A Level Business Studies - Budgeting

Value of Budgeting

Reasons for setting budgets

To gain financial support – a good business plan, incorporating clear budgets that indicate a good chance of success is vital in persuading potential bankers to invest. The quality of a budget can therefore be critical because without it a new business may never be able to get started. The more detail it contains, the more reassurance there is for financial backers looking for a carefully planned business venture.

To ensure that a business does not overspent – careful control of budgets will ensure that a firm’s finances do not worsen unexpectedly, as a result of a failure to limit spending to agreed levels.

To establish priorities – a budget plan is for the future, allocating a large budget can indicate the level of importance a policy or division has. This sends a clear message to stakeholders.

To encourage delegation and responsibility and to motivate staff – budgets mean that junior managers can be budget holders and make decision on spending in areas of the business they have more knowledge on than senior managers. This improves the quality of the decisions and acts as a motivator.

To assign the responsibility – the budget holder is the person who is directly responsible for success/failure. Makes it easier to find out who made the mistake and where credit should be given. Can be included in the appraisal of a manager’s work.

To improve efficiency – businesses can monitor and review budgets and can establish standards and investigate the causes of any successes and failures. They can use this information to improve future decisions. Working to a limited budget encourages efficiency.

Problems of Setting Budgets

Managers may not know enough about the division or department – in this case they will struggle to plan a reasonable budget. Acute issue for new firms/new ventures.

Problems in gathering information - a start-up business can struggle to get financial information from other firms. Initial budgets may contain guesswork and estimation, lacking accuracy.

Unforeseen changes – predicting the future is always difficult and unforeseen changes will undermine the budgeting process.

Level of inflation (price rises) is not easy to predict – businesses tend to use the average inflation rate, but some prices change by greater levels. Farmers have been hit by falling prices, whereas property prices have gone up.

Budgets may be imposed – the budget holder should be involved in setting the budget level. They are often set by senior managers who may misunderstand the needs of a certain area. The budget may be unfair which can reduce motivation. Also, the manager may ignore potential scope for efficiency gains and fail to take account of developments outside that area of the business. Both the senior manager and budget holder should find the time to discuss the budget fully.

Features of Good Budgeting

Consistent with the aims of the business – ensures managers cannot use the company’s finances for projects to boost their own careers, rather than meeting needs of the company.

Based on the opinions of as many people of possible – setting and using a budget is not an exact science and different people may provide different ideas and expertise. Asking a range of people can help the budget holder come up with realistic targets.

Challenging but realistic targets – budgets must be achievable, but only if staff demonstrate a reasonable and expected level of effort and skill in order to reach the target

Monitored at regular intervals, allowing for changes in the business and its environment – allows for a business to improve by identifying situations in which targets are being missed or exceeded. Remedial action can be taken to improve performance. Reasons for beating a target should be looked at so other parts of the business can benefit from good management. The more it is monitored, the more quickly these actions take place.

Be flexible – although budgets should have a set target, it is crucial that budgeting process allows for changing circumstances. If the budget allocation is inadequate it may be good to change it so it is more realistic.

Cobra Beer

Karan Bilimoria, creator of Cobra Beer, believes that careful budgeting is essential and a potentially great motivator. “For any company it is always a question of not only looking 5 years ahead but also breaking those 5 years down into achievable bite-size chunks and targets you can go for. The [income budgets] were ambitious but we managed to beat them all in the end.”