6.

4 BUDGETS AND FORECASTS

6.4.1 Introduction
It is possible to manage a business by continuing as before and responding to events as they
occur. Many small and some large businesses behave in this way and survive. However, even
in these businesses, management has some implicit plans which might be simple such as ‘to
increase sales’ or ‘to reduce costs’ or to explore the possibilities of additional products.
Most businesses prefer to make their plans explicit and may do so in qualitative or quantitative
terms. One of the best ways of approaching the future is by budgeting. Budgeting is making a
plan expressed in monetary terms.
Therefore, a budget is a plan expressed in monetary terms. It is a financial plan for a future
period of time. For instance, the annual budget sets targets for the forthcoming year for all
levels of the business. It is usually broken into monthly budgets that define monthly targets.in
many cases the annual budget will, in any case, be built up from monthly budgets.
6.4.2 Distinction between a budget and forecast
A budget and forecast are distinctly different. A budget is a plan and, to talk of a plan suggests
an intention or determination to achieve the planned targets. On the other hand, forecasts tend
to be predictions of the future state of the environment. Clearly, forecasts are very helpful to
the planner/budget setter. If a reputable forecaster has forecast the tonnage of fertilizer to be
demanded in the next agricultural season in Zambia, it will be valuable for a manager in
fertilizer business to obtain and take account of this forecast figure when setting up sales
budgets.
6.4.3 Functions/ advantages of budgets
1. Planning. Budgets tend to promote forward thinking and the possible identification of
short term problems. For instance, a shortage of production capacity may be identified
during the budgeting process, if the problem is picked up early enough, ways of solving
the problem could be explored and considered rationally. The budget is normally for
one year ahead and should take into account:
 Any longer term planning process
 Expectations of economic conditions and events in ensuing year
 Anticipate problems and difficulties as they may arise.

2. Coordination: A budget in a firm is made up of subsidiary or sectional budgets. It is

important that each budget coordinates with all others. It is crucial that the activities of
the various departments and sections of the business are linked so that activities of one
department are complementary to those of another. For example, the activities of the
purchasing/procurement department of an agribusiness should dove detail with the raw
materials needs of the production departments. If this is not the case, production could
run out of stock, leading to expensive production stoppages. Alternatively, excessive
stocks could be bought, leading to large and unnecessary stock holding costs

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 3. Communication: By communicating the budget to relevant personnel, management
forms staff of its hopes and aspirations. In addition, the formation of a budget requires
that much learning of company objectives and inter-relationships is acquired by staff.
4. Motivation: The budget can be seen as a device for motivating staff to fulfil plans of
management expressed in the budget. They can motivate managers to better
performance. It is well established that simply to tell an employee to do his or her best
is not very motivating, but to define a required level of achievement is likely to
motivate. Moreover, budgets should be set in such a way to offer challenging yet
achievable, targets. It is also felt that some managers are able to relate their particular
role in the business to the overall objectives of the business. Since budgets are directly
derived from corporate objectives, budgeting makes this possible.
5. Control is concerned with ensuring that events conform to plans or finding means of
ensuring that plans are achieved. It is possible to compare current performance with
that which happened last month or last year, or perhaps with what happened in another
business. Yet the most logical yardstick is often planned performance. These
comparisons will set a basis for control. Such a basis will enable the use of management
by exception, a technique whereby senior managers concentrate their energy on areas
where things are not going according to plan. Juniors mangers who are performing to
budget can be left to get on with the job. Budgets should allow junior managers to
exercise self-control, since by knowing what is expected of them and what they have
actually achieved, they can assess how well they are performing and take steps to
correct matters where they are failing to achieve.

6.4.4 Characteristics of a good budget

Below are some the characteristics of a good budget:
 It is expressed in quantitative or monetary terms.
 It is prepared for a fixed period of time and before the period in which it commences.
 Practical to implement.
 It spells out the objects and the policies to be pursued in order to achieve the objectives
of the organisation.
 Successful budgeting is realised when the budget is the result of a process of
consultation and negotiation when all relevant personnel are involved and can bring
their special knowledge to the issue. Budgets imposed from above are rarely effective
as dysfunctional behaviour follows.
 Flexible enough to allow changes in the changing environment.
 Prepared on the basis of established standards of performance.
 Based on detailed analysis of costs and revenues.
 Prepared on the basis that budget report performance of the organisation is constantly
monitored.

6.4.5 Budget preparation

This is normally a process that requires a lot of time and effort, how the process is much
simplified below to give you the foundation of the whole process.

1. Determine the principal budgeting factor which is the item which restricts activity.
Assuming it is sales (it is usually is)
2. Determine the sales budget-itemized by product with quantity and price

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 3. Identify any management policies that need to be incorporated in the budget e.g.
the amount of stock to be held or the average creditors’ payment period etc.
4. Construct subsidiary budgets : purchases, labour, overheads and capital
expenditure budgets
5. Construct a master budget which could be in the form of Profit and Loss account
and Balance sheet

6.4.6 Types of Budgets

Introduction
Much budgeting works on the basis of taking last year’s expenditure and adding on a few
percent for inflation and making any necessary changes for changed circumstance, which is
referred to as traditional (incremental) budgeting. Alternative ways include zero based
budgeting, activity based budgeting and flexible budgeting. These have been discussed below.
6.4.6.1 Zero Based Budgeting (ZBB)
This is a budgeting preparations which for every year must start from the scratch with no pre-
authorised funds. Unlike the traditional (incremental) budgeting in which past sales and
expenditure trends are expected to continue, ZBB requires each activity to be justified on the
basis of cost benefit analysis. It assumes that no present commitment exists, and that there is
no balance to be carried forward. By forcing activities to be ranked according to priority, ZBB
provides a systematic basis for resource allocation. Many organisations apply the normal
budgetary process but select particular activities or departments for ZBB.
6.4.6.2 Activity Based Budgeting
 This refers to an approach to the budgeting process that focuses on identifying the costs
of activities that take place in every area of a business or organisation, and determining
how those activities relate to one another is used to establish goals that allow the
organisation to move forward.
 In addition to helping the company save money, it also forces management to examine
every activity and by doing this, management can become extremely familiar with the
production process as a whole.
 This kind of knowledge can lead to much more than cost savings leading to creation of
realistic budgets for each department that are more equitable in the best interests of the
organisation in the long run activity
6.4.6.3 Using Budgets for Control- Flexible Budgets
Budgets may prove to be totally unrealistic targets due to a variety of reasons, including
unexpected changes in the business environment for instance unexpected decrease in demand
for the product an organisation provides. In this case nothing can be achieved by pretending
that the targets can be met.
One practical way to overcome this difficulty is to ‘flex’ the budget to the different levels of
output. Flexing the budget simply means revising it, to assume a different level of output. In
the context of control, the budget is flexed to reflect the volume that actually occurred, whether
it is higher or lower than the original planned volume.

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To be able to do this we need to know which items are fixed and which are variable, relative
to the volume of output. Once we have this knowledge flexing is a simple operation
We assume that sales revenue, material and labour costs vary strictly with volume. Fixed
overheads, by definition, will not.
On the basis of assumptions made on the behaviour of revenues and costs for instance the sales,
raw material and labour costs are scaled down by the same factor or percentage (%) the actual
output for instance fell short of the budgeted one.
Thereafter you make comparisons between the budget using the flexed figures and actual.
6.4.7 Making Budgetary Control more Effective
 The above types of budgets help to make sure that operational expenses to do not exceed
the projected revenue for a given period, creating a net loss. There are several elements
that can make budgetary control more effective.
 The first step in effective budget control is the creation of a budget that is based on
factual information regarding the revenue needed to operate the business effectively
based on information obtained from consumer markets regarding the prices of different
goods and services to be consumed each month (market scanning).
 The second step is the preparation of a realistic budget, monitoring income levels and
engaging in comparison shopping before actually executing any purchases.