2. (Oxford river)

3. 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

4. 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

5. 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

6. 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

7. 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)

8. 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

9. 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

10. 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

11. 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?

12. 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

13. 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

14. 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

15. 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

16. Principles of good budgetary control