The Use of Budgets in Businesses

The Purpose and Use of Budgets in Businesses

A budget is a detailed plan, expressed in quantitative terms that specifies how resources will be acquired and used during a particular period.
They provide a way of co-ordinating the activities of different parts of an organisation and ensuring that everything comes together in an overall plan.
When developing a budget, businesses should consider their objectives, previous performance, market conditions and the available resources.
An important aspect is budgetary control, which involves comparing actual financial results with the budgeted ones and acting upon discrepancies.

Setting a Budget

The first step in setting a budget is to forecast the sales revenues. The forecasting is generally based on previous sales data, as well as accounting for things like changes in demand, competition, and pricing strategies.
Once the sales revenue is predicted, the business can assess its fixed costs and variable costs, which can help in projecting the total costs.
The next step involves developing a budget for expenses that support the sales effort, such as marketing and advertising.
Companies usually prepare budgets annually, which are then broken down into quarterly or monthly budgets to provide shorter-term control.

Variances in Budget

A variance is the difference between a budgeted, planned, or standard cost and the actual amount incurred/sold.
Variances can be categorized as favorable or unfavorable. A favourable variance indicates that actual costs are less than the standard or expected costs, and an unfavourable variance means the actual costs are more than the budgeted ones.
Regular reviewing and analysing of variances help businesses to amend their budgets and strategies accordingly.

Types of Budget

A sales budget forecasts the sales revenue and the quantities of products the business expects to sell.
An expenditure budget details how much will be spent by a business and is a plan for all expected payments for the business.
An income budget is a plan for expected income and shows all the business’s expected receipts.
A profit budget brings together the sales and expenditure budgets to show the expected profit.

Benefits and Limitations of Budgets

Benefits: Budgets help businesses anticipate problems, provide a framework for decision-making, and facilitate communication and cooperation across departments.
Limitations: However, budgets can be time-consuming and expensive to construct, and can potentially demotivate staff if they are not given a say in the process. They may also discourage innovation as employees might be hesitant to go beyond the set budget. Additionally, budgets are based on predictions which can be uncertain or inaccurate.

Understanding the uses and benefits of budgets as well as their limitations is crucial when learning about financial planning and forecasting, and how businesses make strategic decisions based on their budgeting process.