Topic 6.2 - Budgets & Forecasts
Topic 6.2 - Budgets & Forecasts
Topic 6.2 - Budgets & 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.
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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.
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
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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.