Budgeting Miss Hunter

What is the purpose (Advantages) of budgets? A budget is a financial statement that sets out plans for a future accounting period, such as the next financial year. Businesses use budgets for a number of reasons: Motivation Communication Control Co-ordination Planning

Managers create plans of action rather than just reacting to events as they occur. It helps managers clarify their aims, consider and evaluate alternative courses of action and choose the best course available. It helps to foresee future problems, so solutions to problems can be found in advance, reducing or avoiding their impact.

Co-ordination Co-ordination of activities of all departments. This prevents areas working in isolation, for example a sales department planning a big promotion without consulting the production department. The result could be orders can’t be met.

Control Budgets are a means of financial control and evaluating performance. During, and at the end of an accounting period, a business is likely to compare actual income and expenditure with budgeted amounts, any differences are called variances. A business will investigate the reasons for significant variances and use this information to help improve future performance.

Communication Managers can use budgets to communicate targets with employees, and show how department targets fit in with the overall plans of the business.

Motivation By taking part in budget preparation, staff might feel a greater sense of ‘ownership’ and then try harder to achieve the planned outcomes. Also, managers can be set clear targets, related to the overall goals of the business, which is motivating.

Types of budgets The sales budget The production Purchases budget Debtors budget Creditors budget The cash budget, also known as a cash flow forecast The master budget A budgeted profit and loss account and a budgeted balance sheet. Sometimes called forecast final accounts. For internal use only so not required by the Companies Act

Example question: The following table shows the sales budget for Elizabeth Chan & Co, a new company that makes silk pyjamas. The price of each pair of pyjamas is £100. The company maintains the following policies: Sales are expected to be maintained at 100 units per month during the following year. The company plans to produce at such a level that sufficient stocks of finished goods for each month’s sales are available at the end of the preceding month. A just-in-time production policy is used so that, each month, purchases are just sufficient to meet that month’s production needs. The raw material costs are expected to be £50 per garment. All sales are on one month’s credit. All purchases of raw materials are on one month’s credit.