This essay 3.9 Budgeting has a total of 539 words and 6 pages.
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
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
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
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
The level of expenditure will depend on the following factors:
The amount available
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
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
Stages in production
*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
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
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