BUDGETING AS BUSINESS UNIT 1

BUDGETING A BUDGET IS A FINANCIAL PLAN FOR THE FUTURE. SET USUALLY OVER A 12 MONTH PERIOD. 3 TYPES: INCOME BUDGETS - Forecast the amount of money that will come into the business as revenue. EXPENDITURE BUDGETS - Predicts what the total costs will be for the year for the business. PROFIT BUDGETS - This uses the totals from the income and expenditure budgets to calculate what the expected profit/loss will be.

BUDGETING Income budgets A target set for the amount of revenue to be achieved in a set time period Can be split by products, services or departments May be translated into individual sales targets for staff Informed by market research and sales forecasts

BUDGETING Expenditure budgets A limit placed on the amount to be spent in a given period of time Can be split by department, function or product Responsibility can be passed to individual managers Allows for monitoring of under spending as well as overspending

BUDGETING Profit budgets A target set for the surplus between income and expenditure in a given period of time Calculated based upon the income and expenditure budget Within a business plan will be used to highlight the potential and feasibility of the business

The process of setting budgets Set clear objectives Carry out market research Produce a sales forecast Set income budget Review against objective Set profit budget Set expenditure budget Set divisional targets

Problems in setting budgets Dependent upon predictions and forecasts Costs are subject to change Actions of competitors unknown New entrepreneurs may lack experience Can be restrictive Take time and effort which itself has an associated opportunity cost

Advantages of setting budgets Help control income and expenditure. Spending can be co-ordinated and prioritised They provide a target to hit and this can be motivating for both employees and managers. Budgeting lets businesses and departments review their activities.

Sample budget Jan Feb Mar Income Budget 5000 6000 Expenditure Budget 2500 3500 Profit Budgets

Nihal is setting up a Sri Lankan cook in sauce business offering specialist sauces to deli’s and small food outlets across the north east of England. After careful research he has estimated his income to be £100,000 and has read that on average promotional budgets tend to be between 1 and 5% of income. He is however keen to keep his expenditure budget to a minimum and has therefore decided his promotional budget should be just 2.5%. Use the information sheet to make a recommendation for how Nihal should use his promotional budget – remember you should not overspend but may decide to under spend. BUSS1.14 Setting Budgets

Different budget types FIXED BUDGETS – Budget holders MUST stick to their budget plans. ZERO BUDGETING – Means starting with £0 each year and justifying everything they need getting approval for money. FLEXIBLE BUDGETING – Budgets can be altered to meet changing market conditions/needs of the business. HISTORICAL BUDGETING – Looks at what the business spent the previous year to obtain its allowance for the forthcoming year.

Variances Variance is the difference between the actual budget and the budgeted spend. A variance means the business is performing better or worse than expected. A FAVOURABLE variance leads to increased profit e.g. Costs are lower than expected or revenue is higher than expected.

Variances An ADVERSE variance is a difference that can reduce profits. It may mean selling fewer items than expected or spending more on different aspects of the business than planned e.g. Raw materials. Example a business plans to spend £5,000 on an advertising campaign but actually spends £8,000 then £5,000 - £8,000 = £3,000 adverse variance.

Consider the following budgets for three months’ trading in computer games. Now assume that the following were the actual outcomes. Calculate the variances for each month and then calculate the total (cumulative) variance for each budget. Budget Forecasts November December January TOTALS £ Sales 20,000 45,000 15,000 80,000 Expenditure 5,000 3,000 23,000 Profit 30,000 12,000 57,000 Actual outcomes November December January TOTALS £ Sales 15,000 55,000 9,000 79,000 Expenditure 6,000 2,000 23,000 Profit 40,000 7,000 56,000

The resulting variances would be as follows: November December January TOTALS £ Sales (5,000) adverse 10,000 favourable (6,000) (1,000) Expenditure nil 1,000 Profit