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
