(Oxford river)

What is a budget? A target for costs and revenue that a firm sets for itself and aims to reach over a given time period. It is meant to specify the plan and keep everyone in the company sticking to it Provides a set of figures against which to measure success Can act as a motivator and a source of control for departments and individuals

2 Parts of a Budget Income budget – sets out the minimum target for revenue earned (may be set at departmental or individual level) Expenditure budget – sets out the maximum amount of money that can be spent (controls costs – esp at the departmental level) Budgets are normally set from the top of the company and then divided into budgets for each department or further

Types of Budget Historical Zero-based budgets Most commonly used by firms - revenue (income) and cost (expenditure) budgets are based on the previous year Typically based on how much revenues are expected to grow - spending limits based on this Risk: spending may not be justified – just because a sum was spent one year does not mean it needs to be spent each year – historical budgeting can lead to budgets creeping up & inefficiency setting in Zero-based budgets Every department starts from scratch – not based on last year – each costs must be outlined and justified Very time consuming and expensive but good to do every few years

Budget examples Complete the tables for April – June and July - Sept May June £000 Income 500 520 540 Variable costs 250 260 270 Fixed costs 220 Total costs Profit July August Sept 600 300 280 January February March £000 a Income 400 460 480 b Variable costs 200 230 240 c Fixed costs 220 d=b+c Total costs 420 450 =a-d Profit (20) 10 20 Complete the tables for April – June and July - Sept

Budgeting in a large company Directors decide overall budget for revenues & costs of the company. These are allocated to… Regional managers who divide their budget between… Department managers (it might stop here or they might allocate targets to…) Individual staff (office workers, shop floor workers, etc)

Why delegate budgets? To have more accurate and realistic budgets Senior managers do not have the detailed knowledge of individual areas, so it is better to delegate Local or department managers understand their area of business better so budgets will then be realistic To motivate. If employees are involved in budget setting then: Employees will be motivated to meet them rather than targets which are given to them with no input Tough targets from management will demotivate staff Easy targets will also mean staff do not work hard

Reasons to delegate budgets To measure performance Managers and employees can be measured against the budget We can do this by seeing how actual revenues compare with budget, and how actual costs compare with budget If actual revenues or costs are different to budget, this means there is a variance When Actual revenues are above budget, this is a favourable variance Actual revenues are below budget, this is an adverse variance Actual costs are below budget, this is a favourable variance Actual costs are above budget, this is an adverse variance If the variance means profits are above budget this is favourable and vice versa

What if the budget is not met? Reality can differ from the budget – analysis is required… Why did it happen? Was it the fault of the budget? Was it the fault of those executing the plan? Those, whose budget has not been met, must explain / justify the reasons to those above them (directors must explain to shareholders) Adverse variance is a cause for concern; favourable may be a cause for joy but still needs analysing

Budget variances I remember having to prepare a detailed analysis of why we were above or below. Looked at very very closely. Could you do this in an exam?

More examples Budget Actual Variance Favourable £000 or adverse Revenue 400 380 (20) A Variable costs 200 190 (10) F Fixed costs 120 122 2 Total costs 320 312 (8) Profit 80 68 (12) Budget Actual Variance Favourable £000 or adverse Revenue 400 420 20 F Variable costs 200 210 10 A Fixed costs 120 115 (5) Total costs Profit 600 700 100 240 40

Another example Budget Actual Variance Favourable £000 or adverse Revenue product A 600 650 50 F Revenue product B 580 (20) A Total revenue Variable costs 610 10 Fixed costs 300 280 Total costs Profit

Analysing budgets and variance Management should analyse all significant variances to understand the reason (small variances are probably not worthwhile looking at) It may be that market conditions have changed dramatically (eg recession) so revenues are well below budget Otherwise, budget holders should be held responsible for the variance Adverse variance means budget holder receives poor appraisal, no bonus, no promotion etc Favourable variance means budget holder’s appraisal is positive, may receive a bonus, easier to win promotion Management should learn from both positive and negative variance The best practice from positive variance should be shared with the rest of the firm With a negative variance, closer control may be needed

Budgetary systems Big firms have very complex systems Management can measure variances each month in great detail Can help to spot problems But takes time and resources – information has to be input into a system, and staff need to be trained in its use Smaller firms may not be able or want a full budgetary system Takes a lot of time and money to implement and run Time may be better spent on developing the business

Principles of good budgetary control