Don't miss

Why Businesses use Budgets - Setting Budgets


A budget is a target for costs or revenue that a firm or department must aim to reach over a given period of time. A budgeting system shows how much can be spent, and gives managers a way to check whether they are on track. Most firms use a system of budgetary control as a means of supervision.

The process is as follows:
  1. Make a judgement of the likely sales revenues for the coming year.
  2. Set a cost ceiling that allows for an acceptable level of profit.
  3. This budget for the whole company's cost is then broken down by division, department or by cost centre.
  4. The budget may then be broken down further so that each manager has a budget and therefore some spending power.
In a business start-up, the budget should provide enough spending power to finance vital needs such as building work, decoration, recruiting and paying staff, and marketing. If a manager overspends in one area, s/he knows that it is essential to cut back elsewhere. A good manager gets the best possible value from the budgeted sum.

What is Budgeting for then?
  • To ensure that no department or individual spends more than the company expects, thereby preventing unpleasant surprises.
  • To provide a yardstick against which a manager's success or failure can be measured (and rewarded).
  • To enable spending power to be delegated to local managers who are in a better position to know how best to use firm's money. This should improve and speed up the decision-making processm - and help motivate the local budget holders.
  • Budgeting can motivate the staff in a department. If budget figures are used as a clear basis for assessing their performance it becomes clear to staff what they must achieve in order to be considered successful.
Types of Budgets
Income budget
The income budget sets a minimum target for the desired revenue level to be achieved over a period of time. If a manager knows, halfway through a year, that sales figures have not been strong enough to achieve the target, s/he might decide to run a price promotion or a 'buy one get one free' (BOGOF) offer.

Expenditure budget
The expenditure budget sets a maximum target for costs - for example, the manager of the Derby McDonald's may have a staff budget of £2100 for the month of November. Spending beyond an expenditure budget occasionally will be tolerated, but a manager who persistently overspends is likely to get a stern talking-to. An intelligent boss will also question expenditure underspending (e.g. Not spending the budget for safety training) as this may cause major problems later on.

Profit budget
The profit budget is a function of the previous two budgets. The higher the income budget and the lower the expenditure, the higher the profit. Senior managers should look with care at how a profit achievement may have been a result of cost-cutting that threatens health and safety. Of course, managers are supposed to meet their profit targets, but there is more to running a business successfully than simply getting the numbers right.

For start-ups, setting budgets will be a much tougher job. The entrepreneur will need to rely on: 
  • a 'guesstimate' of likely sales in the early months of the start-up.
  • the entrepreneur's expertise and experience, which will be better if the entrepreneur has worked in the industry before.
  • the entrepreneur's instinct, based on market understanding.
  • a significant level of market research.
As well as budgets benefiting a business, there can be problems when setting a budget:
  • a new firm or new manager lacks experience in knowing what things really cost.
  • a senior manager is too arrogant to listen to his/her staff, and just sets a budget without discussion (successful budgets should be agreed, not set).
  • the type of business makes it hard to set budgets in a meaningful way (meaning that managers struggle to take them seriously).
The sophistication of budgeting systems is usually directly linked to the size of the business. Huge multinationals have incredibly complex budgeting systems. For a small business start-up, any budgeting system is likely to be far more simplistic. Most will rely on a rough breakdown of how the start-up budget is to be divided between the competing demands. There is, however, no doubt that budgeting provides a more effective system of controlling a business's finances than no system at all.

About Will Green

A student in England studying Automotive Engineering with Motorsport, Will created Ask Will Online back in 2010 to help students revise and bloggers make money. You can follow AskWillOnline via @AskWillOnline.

4 comments so far:

  1. In a business start-up, the budgetshould provide enough spending power to financevital needs
    You missed some spaces in the above sentence.
    Near the top of the article.

    ReplyDelete
  2. Thanks for pointing out the typo. I have changed it since.

    ReplyDelete
  3. So glad to come along with a site that offers much specifics of any common subject just like that which you are covering. Appreciate posting, keep up the nice work!

    Mom Entrepreneur

    ReplyDelete
  4. Again, thank you for your great feedback!

    ReplyDelete