Management Accounting: The production and use of financial and accounting information for internal purposes of planning, review and control. It is based on predictions of what will happen and analysis of the actual outcomes in comparison to the original plans.
Income Budgets
An income budget shows the agreed, planned income of a business (or division of a business) over a period of time. Also called revenue budget or sales budget.
This could includes income from sales, rent received or sponsorship (if financial payments are being made by another firm that is using the business' activities for publicity purposes.
Expenditure Budgets
An expenditure budget shows the agreed, planned expenditure of a business (or division of a business) over a period of time.
Costs that may be found in an expenditure budget: Raw materials/components, labour costs, marketing expenditure, administration costs, rent and capital costs.
Start-ups may make a spate expenditure budget to budget for the items they need to start the business. For example: premises, furniture and office equipment, vehicles, insurance, legal costs, salaries and payroll taxes (such as employers' NICs), cleaning and other services.
Profit Budgets
A profit budget shows the agreed, planned profit of a business (or division of a business) over a period of time.
- Result of taking the income budget and subtracting it from the expenditure budget.
Profit = Income - Expenditure
Setting Budgets
- Budgets are usually stated in terms of financial targets, related to money allocated to support the organisation of a particular function.
The eight stages of budget setting:
Step 1= Set objectives - What are each budget trying to achieve?
Step 2= Carry out market research - To discover the probable level of sales volume and the market price for the product/s.
Step 3= Carry out research into costs - Based on sales volume expected
Step 4= Complete the income budget - Will show HOW MUCH needs to be PRODUCED
Step 5= Construct the expenditure budget - To find costs that will be incurred in achieving the sales target
Step 6= Create an overall profit budget - By combining Stage 4 and 5.
Step 7= Draw up divisional or departmental budgets - Done by managers responsible for each area of the business
Step 8= Summarise the detailed budgets in the master budget
Methods of setting Budgets
1. According to company objectives =
- More ambitious --> รก budget needed allocated
- Stay competitive --> Match spending of rivals.
- 2007, Tesco made a campaign of price comparisons between leading supermarkets. Other supermarkets respond by changing their income & expenditure budgets throughout sector.
- Start-ups - budget according to competitors' spending --> More competitive. Start-ups do this because they may be relatively unaware of typical levels of spending and income in their market.
3. As a % of Sales Revenue=
- Less scientific but fair
- Used by organisations (e.g. supermarkets + banks) when allocating budgets to branches
- Used to allocate budget to product managers
4. Zero budgeting=
- Allocated on the strength of the case presented by the project manager.
- Managers must justify all of the money allocated to them
- This ensures allocations are not excessive
- Based on expected outcomes
5. Budgeting according last year's budget allocation=
- Logic is that if the budget was suitable last year, it will be suitable this year.
- Common practice in markets that experience little change
- Uses last year's budget plus an allowance for inflation
- Used widely in public services such as the health service and education.
Reasons for setting budgets:
Problems of setting Budgets
1. Managers may not know enough about the division or department
- Hard to plan a reasonable budget
- Problem particularly acute to new firms or ventures
2. There may be problems in gathering information
- Start-ups may find it hard to get info from other firms
- Consequently, initial budgets made from guesswork, leading to lack of accuracy
3. There may be unforeseen changes
- Difficult to predict future
- Unforeseen changes will undermine the budgeting process
4. The level of inflation (price rises) is not easy to predict
- Businesses usually use the average inflation rates
- Some prices can change by greater levels
- E.g. Property prices have gone up by more than most other prices
5. Budgets may be imposed
- Budget holder should be involved in setting the budget level
- Often set by senior managers who misunderstand the needs of a certain area
- Resulting budget= Unfair, causing resentment + reducing morale
- If a budget is set by only the manager responsible --> Ignore potential scope for efficiency gains, fails to take account of developments outside the area of business.
- Ideally both senior manager and budget holder should be involved in budget setting
6. Setting a budget can be time-consuming
- Not worth it if only marginal improvements are made.
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