- Budgets
- Target for costs or revenue that a firm or department must aim to reach over a given period of time
- Importance of budgets for organizations
- To ensure spending is within the set expectation
- To provide a yardstick against a manager’s success or failure
- To enable spending power to be delegated to the local managers to know how best to use the firm’s money
- Purpose
- Planning and guidance
- Coordination
- Control
- Motivation
- Advantages
- Controls or monitors costs
- Gives an overall picture for the firm
- Vital too when coordinating a firm’s diverse activities
- Motivational effect – they feel trusted and allied
- Limitations
- Not an exact tool
- Budgets can be overestimated so it can be easily be met by managers (may cause complacency or wastefulness)
- Managers may manipulate the budget so their department can get more funds than needed
- Managers who may not be involved in the department may be the ones who set the budget
- Competition over budgets
- Cost centers
- Department or unit of business that incurs costs
- Doesn’t contribute to profit directly.
- e.g. Marketing and HR departments
- Departments must be made aware of their costs to help managers operate within the allocated budget
- Cost centers have to keep their costs below the budgeted/predicted value.
- Profit centers
- Branch of a company that is accounted for on a standalone basis for the purposes of profit calculation
- Similar to revenue streams – sources of revenue/potential profit for a business
- Used to know which aspects of a business are the most and least profitable
- Managers have to be responsible for costs and earnings of their profit center, and they should know how to best use resources to maximize profitability
- Variances
- The amount by which the actual result differs from the budgeted figure
- Usually measured each month by comparing the actual figure with the budget
- Value of regular variance statements
- Provides an early warning; identifying symptoms
- Types of Variances:
- Favorable Variance
- Adverse Variance
- (Not positive or negative. A bigger actual figure for production costs would be adverse, while a bigger actual figure for sales revenue would be favorable.)
- Management by exception (For large corporation)
- In order to avoid information overload, senior managers will concern themselves with departmental budgets which show large variances
- Role of budgets and variances in strategic planning
- Budgeting helps to ensure that managers plan ahead by anticipating the costs and revenues of different business activities
- Budget control encourages regular monitoring and review of budgets to deal with any variances
- Requires managers to investigate causes of any variance from budgets
- Ultimately, effective budgeting avoids inefficient expenditure, and enhances a company’s competitive strength and strategic direction