Unit 3 - Finance and Accounts
3.9 - Budgets
Budgets are financial plans for the future, setting out expected revenues, costs, and profits over a chosen period. They are essential tools for business planning, control, and performance evaluation.
What is a Budget?
- A budget is a quantitative financial plan for a specific time period (e.g., one month, one year).
- It forecasts income (sales, revenue), expected costs (materials, wages, overhead) and anticipated profits.
- Budgets are used by managers for planning (setting targets), controlling spending, coordinating activities, and evaluating performance.
- Budgeting helps ensure resources are properly allocated in line with company goals.
- Actual performance is compared to budgets to measure success.
| Type of Budget | Main Purpose | Examples |
|---|---|---|
| Sales budget | Estimate sales revenue and volume | Sales units, sales revenue |
| Expenditure (cost) budget | Forecasts costs/expenses | Wages, raw materials, rent, utilities |
| Profit budget | Revenue minus costs = target profit | Net profit, gross profit targets |
| Cash flow budget | Predicts inflows and outflows of cash | Tells if the business will run out of cash |
Variance Analysis
Variance is the difference between an actual result and the budgeted/forecasted figure.
\[ \text{Variance} = \text{Actual} - \text{Budgeted} \]
- Favourable variance (F): Actual performance is better than budgeted (e.g., lower costs or higher sales).
- Adverse/unfavourable variance (A): Actual performance is worse than budgeted (e.g., higher costs or lower sales).
\[ \text{Variance} = \text{Actual} - \text{Budgeted} \]
- If variance is positive for revenues, it's favourable.
- If variance is positive for costs, it's adverse (since costs are higher than planned).
Cost Centres & Profit Centres
- Cost Centre: A part of a business (department, section, or individual) where costs can be identified and allocated, but not direct revenue (e.g., HR, maintenance).
- Profit Centre: A unit (division, branch, product line) accountable for both revenues and costs, so its profitability can be measured (e.g., a shop branch or product team).
Benefits:
- Improves accountability and performance tracking
- Allows benchmarking between centres/divisions
- Allows targeted cost control and responsibility
How to Construct a Budget
- Set objectives: What is the budget aiming to achieve? (Sales growth, cost control, project launch?)
- Gather data: Use past performance, market research, and estimates for revenues and costs.
- Estimate revenues and costs: Forecast all potential income and expenditure.
- Negotiate: Collaborate with managers & teams for realistic and accepted budgets.
- Allocate resources: Allocate funds to departments and activities per strategic priorities.
- Document & communicate: Write the budget out formally and share with relevant staff.
- Monitor & review: Regularly compare actual results with budget, analyze variances, and make adjustments.
Zero-based budgeting: Managers justify all expenses from scratch each period, not just changes from last year.
Key Takeaways
- Budgets provide benchmarks for planning, control, and performance review.
- Variance analysis highlights where things went better or worse than planned—so action can be taken promptly.
- Cost and profit centres support responsibility accounting and targeted management.
- Good budgeting means clear objectives, realistic data, clear documentation, participation, and ongoing monitoring.