Setting budgets
Budgeting is the process of setting targets, covering all aspects of costs and revenues. It is a method for turning a firm’s strategy into reality. Budgets tell individual managers how much they can spend to achieve their objectives. A budgeting system shows how much can be spent, and gives managers a way to check whether they are on track. Most firms use a system of budgetary control as a means of supervision. The process is as follows: * Make a judgement of the likely sales revenues for the coming year. * Set a cost ceiling that allows for an acceptable level of profit. * This budget for the whole company’s costs is then broken down by division, department or by cost centre. * The budget may then be broken down further so that each manager has a budget and therefore spending power
What is budgeting for?
Budgeting is used: * To ensure that no department or individual spends more than the company expects, thereby preventing unpleasant surprises. * To provide a yardstick against a manager’s success or failure can be measured and rewarded. For example a store manager may have to meet a monthly sales budget of £25,000 at a maximum operating cost of £18,000. As long as the budget holder believes this target is possible the attempt to achieve it will be motivating. * To enable spending power to be delegated to local managers who are in a better position to know how best to use the firms money. This should improve and speed up decision making process and help motivate the local budget holders. * Budgeting can motivate the staff in a department. If budget figures are used as a clear basis for assessing their performance it become clear to staff what they must achieve in order to be considered successful.
For start-ups, setting budgets will be a much tougher job. The entrepreneur will need to rely on: * A ‘guesstimate’ of likely sales in the early months of the start up * The entrepreneurs expertise and experience, which will be better if the entrepreneur has worked in the industry before * The entrepreneurs instinct, based on market understanding * A significant level of market research
Types of budget
Income budget
The income budget sets a minimum target for the desired revenue level to be achieved over a period of time. If a manager knows, halfway through the year, that sales figures have not been strong enough to achieve the target, she or he might decide to run a price promotion or a ‘buy one get one free’ offer.
Expenditure budget
The expenditure budget sets a maximum target for costs; for example, the manager of the Derby McDonalds may have a staff budget of £2,100 for the month of December. Spending beyond an expenditure budget occasionally will be tolerated, but a manager who persistently overspends is likely to get a stern talking to. An intelligent boss will also question expenditure under spending.
Profit budget
The profit budget is a function of the previous two budgets: the higher the income budget and the lower the expenditure, the higher the profit. The profit achievements may have been a result of cost cutting that threatens health and safety
Budgetary variances
Variance is the amount by which the actual result differs from the budgeted figure. It is usually measured each month, by comparing the actual outcome with the budgeted one. It is important to note that variances are referred to as adverse or favourable – not positive or negative. A favourable is one that leads to higher expected profit. An adverse variance is one that reduces profit, such as costs being higher that the budgeted level.

B4 1. Firms without a budget can overspend by spending money on unnecessarily extravagant business trips. It can also allow employees to make their own business trip arrangements and claim they can spend what they want. 2. It would help a small business as it will allow them to not overspend and have more control of what is spent. 3.