1. Unit 3 Accounts & Finance Budgeting

2. Learning Objectives Understand the importance of budgeting for organisations Calculate and interpret variances Analyse the role of budgets and variances in strategic planning

3. What are budgets? A budget is a financial plan for the future. A budget forecasts future earnings and future spending, usually over a 12 month period Budgets attempt to consider what the future might bring. Managers must think carefully when making budgets or their predictions will be unrealistic and meaningless Budgets with a company will be broken down by department A budget will often break down the revenue and expenditure sections into many detailed categories Budget holders are the people responsible for generating or spending the money for each budget e.g. the budget holder of the IT Dept would be the Head of IT. Department budgets are broken down into budgets for specific activities All functional budgets are added together to provide a master budget which forecasts total expenditure.

4. Budgeting Setting budgets and establishing financial plans for the future have seven main purposes 1.Planning 2.Effective allocation of resources 3.Setting targets to be achieved 4.Co-ordination 5.Monitoring and controlling 6.Modifying 7.Assessing performance

5. What is the point of budgets? One of the best reasons to have a budget is so that managers can use it to monitor the business throughout the year. If you set planned marketing expenses at £200,000 per month, you might notice the figure going above the planned level if your marketing department was overspending. This would alert you to a problem which you might be able to solve. Budgets allow managers to control their spending. The master budget helps businesses understand their cash flow situation Budgets set targets that can be used to control or motivate staff, depending on management style. To allow spending power to be delegated to local managers who are in a better position to know how best to use the organisation’s company

6. Example Budget Master Budget = £375,000 Market research £5000 Advertising brand A £12,000 PR budget £20,000 R&D budget £25,000 Raw materials budget £100,000 Marketing budget £50,000 Wages budget £200,000 Advertising brand B £13,000

7. Delegated Budgets Budget will be used to review the performance of a department and of the managers These stages of involvement in constructing the budget, taking responsibility and being appraised are crucial and play an important role in the motivation of staff

8. External factors Organisational objectives Forecasts of the future What happened last year Key factor – likely to be sales Sales budget: By product by region by department Cash budget Administration budgetMaterials budget Selling / distribution budget Co-ordination essential Master budget: Balance sheet and profit & loss account

9. Stages in setting budgets Stage 1 – organisational objectives for the coming year are established Stage 2 – the key or limiting factor that is most likely to influence the growth or success of the organisation must be identified (usually sales) Stage 3 – Sales budget is prepared Stage 4 – Subsidiary budgets are prepared Stage 5 – Co-ordination of budgets Stage 6 – Master budget is prepared Stage 7 – Master budget is presented to board of directors / CEO

10. Stages in setting budgets Once approved, budgets will be basis of operational plans for each department

11. Setting budget levels 1.Incremental Budgeting – Uses last years budget as a basis and an adjustment is made for the coming year 2.Zero Budgeting – Setting budgets to zero each year and budget holders have to argue their case to receive any finance

12. Task Which industry / business would use which type of budgeting and why?

13. Limitations of budgeting Lack of flexibility Focused on the short term Result in unnecessary spending

14. Budgetary control – Variance analysis At the end of the budget period, the performance of the organisation needs to be compared with the original targets set and differences needs to be investigated The process is called Variance Analysis Variance is the difference between budgeted and actual figures

15. Variance Analysis It is essential because: – It measures the differences from the planned performance of each department both month by month and at the end of the year – Assists in analysing the deviations from budget – An understanding of the deviations can be used to change future budgets – Appraisals for budget holders

16. Variances Adverse variance – Exists when the difference between the budgeted and actual figure leads to a lower than expected profit Favourable variance – Exists when the difference between the budgeted and actual figure leads to a higher than expected profit

17. Responding to variance analysis Managers may need to respond quickly to both adverse and favourable variances

18. Budgetary control and strategic planning Setting, agreeing and controlling budgets is time consuming Budgets can fail to reflect the changing internal and external environment causing them to be inflexible So then, is the budgetary process worthwhile? – Why? – Why not?