All organizations of whatever shape or form need to plan in advance what they intend to do in future. This short term plan is what is often referred to as ‘the Budget’. Please refer to the other handout for a fuller discussion of what a budget is.
Let us look at the definitions of some key terms which are often used when talking about budgeting.
Definitions of some key terms
Budget – A budget is a plan expressed in money terms. It is usually prepared and approved prior to the time period to which it relates. It expresses the income to be generated and expenditure to be incurred during that time period.
Budgetary control – It the establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objectives of the policy or to provide a basis for its revision.
Budget centre – A budget centre is a section of an entity for which control may be exercised and budget prepared.
Budget Period – This is the period for which a budget is prepared and used; which may then be subdivided into control periods.
The Budget committee – This is a committee of senior executives of the organization responsible for various functions. Each member of the committee prepares the budget for his/her area of responsibility and presents it to the committee for discussions and subsequent approval.
The Budget Manager – The budget manager is normally a senior accountant within the organization appointed by the budget committee to oversee the preparation and other activities relating to the budget.
The Budget Manual – This is an instructional document prepared by the budget manager to assist members of the budget committee in preparing the budgets of their areas.
Budgetary Slack or Bias – Budgetary slack or bias is one of the behavioral aspects of budgeting which senior managers of organizations must ensure does not creep into budgetary planning. It is an act of making things look better than they really are for instance stating that the cost of an activity would be £2m when the individual is reasonably certain that the true cost will be £1.8m.
Principal budget factor or Key factor or Limiting factor – A principal budget factor is any resource which is capable of limiting the activities of an undertaking and which is taken into account in preparing the budget.
The Master budget – Is a summary of all the functional budgets and it is usually made up of (1) Cash Budget (2) Budgeted Profit & Loss Account (3) Budgeted Balance Sheet.
Why do we prepare budgets?
To aid the planning of annual operations
To co-ordinate the activities of the various parts of the organization in order to ensure that there is a unity of purpose.
To communicate plans to the various responsible centre managers.
To motivate staff in order to achieve the objectives of the organization.
To control activities
To measure managerial performance.
Types of Budget
a) Fixed or Master budget – A fixed or master budget is one that is not designed to change. It is based on a given level of activity. It is used only for planning purposes and therefore a’ before event’ budget.
b) Flexible budget – Is one which recognizes that some costs are fixed and some are variable, as a result any difference in the volume of activity will bring about a difference in cost. This type of budget is used mainly for control purposes. It could be a ‘before event’ budget to enable costs at different activity levels to be compared or an ‘after event’ budget to enable control to be exercised.
1. Incremental Budgets
2. Zero Based Budgets
3. Programme Planning Budgets
4. Rolling Budgets
Weaknesses of Budgets
a) They are not designed to cope with rapid change.
b) They focus on short-term financial targets rather than rapid creation.
c) They encourage a top-down approach to