IB Business and Management
3.4 Budgeting (HL)
Learning Outcomes
• the importance of budgeting for
organisations (AO2)
• The difference between cost and profit
centres (AO1)
• The roles of cost and profit centres
• Variances (AO2, AO3)
• the role of budgets and variances in
strategic planning (AO2)
What is a budget?
• A budget is a financial
plan for costs and/or
revenues for a given
future period of time.
• Budget holders will be
given responsibility for
different areas of the
business
UK Government Budget 2013
What would the benefits of creating a
budget be?
BENEFITS OF BUDGETING
Why set budgets?
• To control (reduce) expenditure
• To forecast outcomes
• To allocate resources
• To promote forward thinking
• To set targets in numerical terms
• To assign financial responsibilities
to budget holders
• To provide motivation for managers
• To improve efficiency
• To evaluate performance (compare
actual performance against the
budget )
Types of Budget
Sales Budgets
Expenditure Budgets
Master Budget
Sales Budgets
A sales budget is the budget
for sales revenue.
This could be broken down
into:
- Product Lines
- Departments
- Branches
• What information would be
needed in order to produce
a sales budget
Expenditure Budgets
An expenditure budget is the
plan for how much will be
spent.
This will be broken down into
different categories.
What type of expenditures
will businesses have to
budget for?
Key Expenditure Types
•
•
•
•
•
•
•
•
Staffing
Training
Marketing
Utilities
Rent
Maintenance
Equipment purchase
Administration
Raw Materials
Contingency
How could these types be broken down even further in order to create a
detailed budget?
Master Budgets
• The master budget
pulls together all of
the other budgets to
provide an overall
plan.
• As all costs and
revenues are now
planned for,
budgeted profit/loss
figures can be
determined
What are they and what is the difference?
COST AND PROFIT CENTRES
What is the difference between cost and profit
centres?
What might be some examples of each?
Profit Centres
This is a section of the business in which both costs and
revenues can be identified.
It that part of the business which is accountable for costs
and revenues. It may be called a business centre,
business unit, or strategic business unit.
Examples of Profit Centres
• Each branch of a chain of shops, restaurant or store
• A sales person
• Each department of a store
• Each product of a multi product firm
Cost Centres
These are individual parts of the business that incurs
costs but is not directly involved in making any
profit.
A Cost Centre is part of a business for which costs can
be identified and easily recorded. For example:
• a functional department such as marketing or
human resources
• an employee
• an item of equipment, e.g. a photocopier, telephone
line or vehicle.
Costs and Profit Centres – How they
are used
• As a business grows bigger it becomes more
difficult to manage its finances. Often businesses
will be divided up into cost/profit centres.
• Budgets will be drawn up for each cost/profit centre
• Each Cost/Profit centre has a manager who is
responsible for decision making and in making sure
that budgets are met
• Senior managers can monitor the performance of
each cost/profit centre over time and also compare
with other cost/profit centres
Benefits and drawbacks of
Cost/Profit Centres?
• What do you think are the main benefits of
cost/profit centres?
In summary….
ADVANTAGES OF COST AND PROFIT
DISADVANTAGES OF COST AND PROFIT
CENTRES
CENTRES
* Some control of operations is
* parts of the firm can put themselves
delegated to the local level, which can
before the business as a whole
be motivating
*
The success and failures of individual *
departments can be identified clearly
The reason for good or bad
performance may be external to the
cost centre, and not under its control
*
Problems can be traced more easily
*
Not all costs and revenues can be
associated directly with a particular
part of the firm
*
Decision making is aided
*
They can create extra pressure on more
junior managers
How are budgets set?
APPROACHES TO BUDGETING
Top Down Budgeting
Budgets are prepared by top management
and imposed on the lower layers of the
organisation.
What are the advantages/disadvantages of
this method?
Bottom up Budgeting
Supervisors and middle managers prepare
the budgets and then forward them up the
chain of command for review and approval.
Zero budgeting
Zero based budgets exist when budgets are
automatically set at zero and budget holders have to
justify their case to receive any funds.
What would be the advantages and disadvantages of
using this approach?
Zero budgeting
• Pros:
• Zero-based budgeting represents a move towards
allocation of resources by need and benefit.
• It creates a questioning attitude rather than one which
assumes that current practice represents value for money.
• It focuses attention on outputs in relation to value for money.
• It leads to increased staff involvement which may lead to
improved motivation and greater interest in the job.
• Cons:
• Effective zero budgeting requires considerable
management time spent in identifying and justifying the
appropriate budget level.
• Bigger budgets may go to those more persuasive managers
rather then those most in need of funds
What information would managers need to know before they can set
budgets for the following year?
PRE-BUDGETING RESEARCH
Setting budgets
• Many firms will work on last years budget
and other historical data and try and build in
adjustments to take account of
– expected changes in demand
– price changes
– cost rises
This is known as Incremental budgeting
Other considerations
•
•
•
•
Available finance
Company objectives
Planned purchases
Negotiation process
Budgets for New Businesses
Budget setting will be harder for a new
business as they don’t have access to
historical data.
What information will they use instead?
Information about competitor products
Market research
Entrepreneur expertise and experience
Instinct based on market knowledge
BUDGETARY CONTROL –
VARIANCE ANALYSIS
Variance Analysis
• Budgetary control involves corrective
measures being taken to ensure that actual
performance meets budgeted performance
• VARIANCE ANALYSIS is the practice of
examining any differences between
budgeted and actual performance and
investigating causes
• Corrective Action can be taken or
amendments to the budget made
Budgeting – An ongoing process
Budget variances
A Variance is the amount by which the actual
result differs from the budgeted figure.
• Variance = Actual outcome – Budgeted
Outcome
• A favourable variance is one that leads to
higher than expected profits.
• An adverse variance is one that reduces
profit.
Example Budget - January
Budgeted
Actual
Variance
Sales
5,000
5,020
20
Stock
1,050
1,060
10
Wages
1,400
1,370
30
Salaries
400
410
10
Power
200
200
0
Profit
1,950
1,980
30
F/A
Favourable
Unfavourable
Favourable
Unfavourable
Favourable
Task
• Watch the video clip ‘Variance Analysis’ (7
mins)
Analysing Variances
What could the potential reasons
be for the following variances?
And what should be done?
More money has been spent on
stock than budgeted for
Wage costs are lower than
budgeted figures
Sales figures are lower than
budget
Task
Complete the worksheet
Edex 6 Budgets and Variances
POTENTIAL PROBLEMS WITH
BUDGETING
Important issues regarding
budgets….
• What happens if there is an unexpected change that
affects costs or revenues?
• What happens if a budget holder spends less than
their budgeted figure?
• What happens if all of the budgeted amount has
already been spent way before the end of the year?
• How can it be ensured that budgets are fairly
allocated?
• What happens if an unexpected opportunity has
arisen but it has not been budgeted for?
Task – In pairs
Write a list of:
• Benefits of budgeting to a business
• Potential Problems with budgeting
Summary
• Watch the video
‘Accounting and Finance - Budgeting’ (6
mins)
Add any additional points to your notes
Do you have any further questions relating to
budgeting?
Evaluation
• A useful management tool. And help to
COORDINATE, CONTROL and MOTIVATE
• They force businesses to plan ahead and
think about the needs of the business
• Thought needs to be given to the budgeting
process in order to avoid problems
associated with budgeting
• Good budgets should be flexible and
reviewed regularly
Homework Task
• Answer questions a-c
• Grimsby and Dyke
There are no past IB questions on budgeting
(apart from explaining benefits) Is this a sign
it is due to come up soon?