Budgets

Covers AS90843

What a budget is

A budget is a financial plan for a future period: how much the business expects to receive and how much it expects to spend.
It is prepared before the period begins, which is what makes it a plan rather than a record.
Common budgets in a large business:
- Sales (revenue) budget — expected income from sales
- Expenditure budget — expected costs, by category
- Cash budget — expected cash in and out each month, showing when the business will be short
- Capital expenditure budget — planned spending on equipment, vehicles and buildings

Why budgets are prepared

To plan. Managers must know whether a proposed investment can actually be afforded before committing to it.
To allocate resources. A budget forces a choice between competing demands from different departments.
To control. Once the period is over, actual figures are compared with the budget — this is variance analysis, and it is only possible because a budget existed.
To set targets and motivate. A department with a budget has something to be measured against.
To support borrowing. Lenders expect a budget and a cash flow forecast before approving finance.

How budgets aid decision making

A budget converts a decision into numbers over time, which is what turns "can we afford this?" into an answerable question:
- When the spending falls due
- When the resulting revenue is expected to arrive
- Whether the business has enough cash in the months in between
The timing matters as much as the total. A profitable investment can still sink a business if the money goes out in March and comes back in November.

Limitations

A budget is a forecast, and forecasts are built on assumptions about prices, demand and costs that may be wrong.
Budgets set from last year's figures repeat last year's inefficiencies.
They can encourage the wrong behaviour: a manager who underspends may have their budget cut next year, so they spend to protect it.
A budget set too tight demotivates staff who can see it is unachievable; set too loose, it controls nothing.

What a budget is

A budget is a financial plan for a future period: how much the business expects to receive and how much it expects to spend.

It is prepared before the period begins, which is what makes it a plan rather than a record.

Common budgets in a large business:

Sales (revenue) budget — expected income from sales
Expenditure budget — expected costs, by category
Cash budget — expected cash in and out each month, showing when the business will be short
Capital expenditure budget — planned spending on equipment, vehicles and buildings

Why budgets are prepared

To plan. Managers must know whether a proposed investment can actually be afforded before committing to it.

To allocate resources. A budget forces a choice between competing demands from different departments.

To control. Once the period is over, actual figures are compared with the budget — this is variance analysis, and it is only possible because a budget existed.

To set targets and motivate. A department with a budget has something to be measured against.

To support borrowing. Lenders expect a budget and a cash flow forecast before approving finance.

How budgets aid decision making

A budget converts a decision into numbers over time, which is what turns "can we afford this?" into an answerable question:

When the spending falls due
When the resulting revenue is expected to arrive
Whether the business has enough cash in the months in between

The timing matters as much as the total. A profitable investment can still sink a business if the money goes out in March and comes back in November.

Limitations

A budget is a forecast, and forecasts are built on assumptions about prices, demand and costs that may be wrong.

Budgets set from last year's figures repeat last year's inefficiencies.

They can encourage the wrong behaviour: a manager who underspends may have their budget cut next year, so they spend to protect it.

A budget set too tight demotivates staff who can see it is unachievable; set too loose, it controls nothing.