3.4 Budgeting HL Chapter 21

What is a Budget? A budget is a detailed financial plan for the future. A budget holder is the individual responsible for setting the budget and achieving the budget. A budget time frame is usually 12 months.

7 Stages in Setting Budgets Stage 1: Objectives are set for the year. Considers previous performance External changes that are likely to affect the business Sales forecasts based on research and past sales data

7 Stages in Setting Budgets Stage 2: Key factors to next year’s growth must be identified – usually sales. All other budgets will be based on this data so it is important that it is as accurate as possible. Stage 3: Sales budget is prepared. All other budgets will be based on this data so it is important that it is as accurate as possible.

7 Stages in Setting Budgets Stage 4: Subsidiary budgets are prepared. Cash budget Materials cost budget Selling and labor cost budget Administration cost budget Stage 5: Subsidiary budgets are coordinated with others. Budgets will be reviewed by management

7 Stages in Setting Budgets Stage 6: Master budget is prepared. Contains all details of subsidiary budgets Includes budgeted profits and loss accounts (Income Statement) Includes budgeted balance sheet Stage 7: Budget is presented to Board of Directors for approval.

Budget Levels Incremental Budget Using last year’s budget as a basis for this year’s budget making needed adjustments. Zero Budget Setting budgets to zero each year and starting over justifying each new budget.

Limitations of Budgets Lack of flexibility: what happens if something unforeseen occurs? Focused on the short term: Managers may make decisions for the short-term without considering the long-term interests of the business. Unnecessary spending: If there is extra money in the department budget, it may be spent for fear of not receiving the same resources next year. Training: Mangers must be trained to set and manage budgets. Setting Budgets for new projects: One-off projects may be difficult to set and follow a budget; frequent revisions may be necessary.

Variance Analysis Throughout the budget period the actual performance needs to be compared with the budgeted performance. Differences need to be investigated. This process is known as variance analysis.

Variance Analysis Measures differences between actual and budgeted amounts (month-by-month and by year) Helps locate causes of deviation from the budget. An understanding of issues so changes in future budgets are more accurate. Each subsidiary budget can be reviewed and evaluated in an objective way.

Variance Analysis Adverse Variance When the difference between the budgeted and actual figure leads to a lower than expected profit. Favorable Variance When the difference between the budgeted and actual figure leads to a higher than expected profit.

Budgetary Control & Strategic Planning Without a detailed plan to allocate money resources who would decide “who gets what?” Without a sales budget how would we know how much to produce or how many people to employ? How would we measure performance without clear targets? Without a budget to measure our progress how would know if we were on track or where changes were needed to be successful? Budgets gives responsibility and a sense of direction.