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:
- Make a judgement of the likely sales revenues for the coming year.
- Set a cost ceiling that allows for an acceptable level of profit.
- This budget for the whole company's cost is then broken down by division, department or by cost centre.
- The budget may then be broken down further so that each manager has a budget and therefore some spending power.
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.
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.
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.
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.
- 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.
- 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).