13.2. Budgetary Control

Preparing a budget

Budgeting allows business managers to improve their control over individual departments or divisions within their organisation. A budget is a financial plan or statement which is agreed in advance. It is not a forecast, but a planned outcome which a firm hopes to achieve. It shows how much money is needed for spending, and how this expenditure might be financed. Most budgets will cover the next 12-month period, but some budget plans are drawn up for longer periods of time. For example, R&D may involve spending large amounts of money over many years.

Budgets can be zero-based (i.e. not based on past information), flexible (i.e. adjusted over time in response to unforeseen changes in the level of activity in a firm), or fixed (i.e. remaining the same independent of any changes).

The government also prepares a budget each December for the economy as a whole. This is a statement of planned public expenditures and expected revenues in the coming financial year.

The preparation of budgets is an important aspect of business planning. Budgets will help an organisation to:

Appraise alternative courses of action – for example, identifying the costs and benefits of employing additional labour to raise output, or investing in new machinery instead.

Present information to potential lenders to raise finance.

Set business targets, as expressed by the amount and cost of resources shown in budget plans.

Monitor business performance by comparing plans with actual results.

Monitoring budgets

If an organisation is to be successful, it is important that it is always fully aware of its current financial situation. Business managers must therefore make sure that certain key areas of the organisation are closely monitored:

The sales budget shows planned revenues the firm hopes to achieve each month. This is calculated by multiplying predicted sales by the product prices the firm hopes to achieve.

The production budget shows the amount of materials, labour hours, and machine hours needed to meet sales targets.

All other operating budgets will be based on the sales and production budgets. These will include budgets for labour and materials, overheads, and cashflow.

Summary budgets may also be drawn up separately for all capital and current expenditures. Current expenditures include wages, materials purchases, spending on power, and overhead expenses. Capital expenditures include spending on plant and machinery, vehicles, and other equipment that will remain productive for a long time. It will also include plans for loans to finance such expenditure.

It is possible to monitor business performance and the attainment of targets by comparing actual results, or outturn, with what had been planned for each month. The difference between what was planned and what is actual is called the variance. For example, suppose that the personnel department in a firm has been allocated a budget for consumables, such as paper and pens, of £100 per month. If it spends £150 on these items in one month, then the variance is negative. That is, £50 more was spent than had been budgeted for. If the department is unable to cut back its spending on these items in future months, this negative variance will be carried forward to the end of the year.

At the end of each budget period, the projected balance sheet can be compared with the balance sheet drawn upon the basis of the actual results.