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Lecture notes on Budgeting
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Explanation of budgeting and its uses with a couple of detailed examples
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Unit 7 – BudgetingBudgets and What they’re for
A budget is the business’ plan for a short term, usually for a year, and is expressed mainly in
financial terms, when not financial it will be numerical such as machine hours. It is useful at
promoting thinking into the future, however this isn’t the only way, and identifying any
short-term problems and if these are identified at the planning stage the business can do
something to avoid these becoming major issues.
Ensures that different sections of the business are working towards business objectives. For
example to do the production planning, the production department will need to talk to the
materials purchasing department to see if they can purchase all the materials, or HR
regarding recruitment and training, or distribution department, if they’re planning to
increase production they need to make sure distribution can get them to the customer. And
so on. So having the budgeting process means that in order to put figures into a budget,
figures need to be known from other departments.
Facilitates co-ordination between different sections of an organisation, relationships
between real people are built thus helping with the cooperation and coordination on a day-
to-day business basis. Different departments have a better understanding of what each does
and constraints on their operations
Can be used as a series of targets, the budget is the plan for the business and then split
down for different departments which then becomes targets for the manager of that
department. This can be expressed in terms of cost control, profit (depending on what the
departmental manager has control over). Therefore these targets help to motivate
managers towards better performance.
Provides a basis for controlling, by having a plan a business can compare what actually
happened with what was planned to happen and evaluate what worked and what didn’t
work. Business would be primarily concerned with what went wrong, however they may be
interested in what went better than expected as this can have a knock-on-effect for the
future.
What Needs to be Taken into Account
Top management should begin by setting their long-term strategic plans.
Budgets will use forecasts of certain conditions that will affect the business, for example
cost structures, if your dependent on costs that come in from outside the business, demand
for the product / service.
Budget will take constraints into account, there may be constraints in the short-term that
can be delt with in the long-term such as staffing or production capacity.
, Example: Three Month Cash Budget
Rocket Ltd has £1,000 cash on 1st day of month 1.
Anticipated sales are all in cash, and are £2,200 for month 1, £4,000 for month 2, and
£5,000 for month 3.
Purchases of stock are for cash, anticipated to be £1,300 for month 1, £3,400 for month 2,
and £3,900 in month 3.
Rent payable = £500 in cash, months 1 and 3
Other costs = £500 in month 1, £0 in month 2, £200 in month 3.
How much is anticipated to be in the bank at the end of month 3?
Month 1 Month 2 Month 3
Receipts from Sales £2,200 £4,000 £5,000
Total Cash Inflows £2,200 £4,000 £5,000
Purchase £1,300 £3,400 £3,900
Rent £500 £0 £500
Other Costs £500 £0 £200
Total Cash Outflows £2,300 £3,400 £4,600
Net Cash Inflow (£100) £600 £400
Opening Balance £1,000 £900 £1,500
Closing Balance £900 £1,500 £1,900
Example 2: 3 Month Budget
The owners of a developing business, Peckham Ltd have asked you to create a
monthly budget for the three months January to March.
It is anticipated that in January, 200 widgets will be sold. In February, 300 widgets
will be sold, and in March, 400 widgets will be sold. 300 widgets were sold in
December.
Each widget will sell at £100, and will cost 75% of the selling price. No inventories are
held. Purchases are paid 60% in cash and 40% in the following month.
Customers pay 50% in cash and 50% one month later. Rent costs will be £36,000 per
year, paid quarterly in advance in January, April, July and October
Advertising and selling costs will be £1,000 in January, £2,000 in February, and
£2,000 in March
Administrative costs will be £2,000 in January, £3,000 in February and £2,500 in
March
Opening cash balance £2,000
Calculations:
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