3.9.

Budgets (HL only)

 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