3.9 Budgeting Essays - Economy, Finance, Money, Free Essays

3.9 Budgeting Essays - Economy, Finance, Money, Free Essays 3.9 Budgeting What is a budget? A forward financial plan that covers all the aspects of a business costs and revenues (forecast) Why prepare a budget? To exercise control within a business It can provide direction and coordination To ensure that no department has an overspend Sets targets that performance can be judged against, which can motivate workers To delegate spending power to individuals or departments Budgetary Control The process by which financial control is exercise within an organization Budgets for revenue and expenditure are prepared in advance and compared with an actual performance to establish any variances Managers are held responsible for any adverse variances and will need to take action TYPES OF BUDGET Zero Budgeting Budgeted costs and revenues are set to zero Budget is based on new proposals for costs and sales Time consuming, but starting from scratch can ensure that funds are allocated the right way Historical Budgeting Use last years figures and add a little for inflation It is much quicker and simple but may not focus on problem areas of the business It does not encourage efficiency BUDGET ALLOCATION The level of expenditure will depend on the following factors: The amount available Inflation External factors This is a difficult task for certain businesses, as prices fluctuate and sales figures are unpredictable (e.g. restaurants, agriculture, and clothing company) VARIANCES - The measure of the anticipated performance (the budget) against what actually happened. The variance is the difference between the two. Favorable (positive) Variance Variance higher than expected Costs lower than expected Revenue higher than expected Budget is higher than actual Adverse (negative) Variance Variance lower than expected Costs higher than expected Revenue lower than expected Budget is lower than actual ADVANTAGES DISADVANTAGES Budgets are an efficient way to control and monitor costs Budgets are based on assumptions and are not exact Can be used as a motivational tool External factors, e.g. the economy, make it almost impossible to set accurate budgets, so could be classed as time wasting Can be used to set target and judge performance Could be demoralizing if set incorrectly Managers take short-term decision in order to meet budgetary requirements. COST AND PROFIT CENTERS COST CENTER - a section of a business, such as a department, to which all costs can be allocated or charged Examples: Manufacturing Products Factories Departments Stages in production Hotel The restaurant The reception Conference station Bar *Different businesses will use different cost centers that are appropriate to their own needs. PROFIT CENTER - a section of a business to which both costs and revenues can be allocated Examples: Each branch of a chain of shops Each department or department store In a multi-product firm, each product in the overall portfolio of the business Why do businesses divide operations into cost and profit centers? Managers and staff will have targets to work towards - if reasonable and achievable - positive impact on motivation Targets can be used to compare with actual performance and help identify those areas performing well and those not so well The individual performances of divisions and their managers can be assessed and compared Work can be monitored and decision made about the future However, Managers and workers may consider their part of the business to be more important than the whole organization Some costs - indirect costs - can be impossible to allocate to cost and profit centers accurately (arbitrary overhead allocation) Reasons for the good or bad performance of one particular profit center may be due to external factors not under its control