Budgets are used to plan the performance of a business and usually focus on the finance, but can also be used to plan output. The budget can be checked against the actual performance to analyse whether any changes need to be made for future performance.
A variance is the difference between the actual figures and the figures produced in the budget. Variance is often used in management accounting to make effective decisions based on information received.
What are the advantages of budgeting?
Budgeting allows managers to have greater control of a company, making decisions based on variances. If variances are unfavourable, which is when the actual outcome isn’t as good as the budget, measures can be put in place to improve outcomes. For instance, if the production is not high enough, management could look at the efficiency of the workforce or remove inefficient practices. If sales aren’t high enough, measures could be put in place to improve marketing or review the products.
Budgets allow a company to work towards a long-term goal, possibly with each department of a company having its own budget. Performance can be measured using budgets, and action taken if performance doesn’t meet the required standard. Variances will indicate whether the company has exceeded the targets or failed to meet them.
Although budgets can be flexible and change according to circumstances and external factors, they give the company and its workforce something to work towards. Regular monitoring is required for budgeting so that changes can be made where necessary. It should be approached in three stages: creating the budget, monitoring the budget and the result, and then taking action.
Budgeting is often confused with forecasting, but forecasts are based on past results and outcomes, whereas a budget is based on expectations for the future. Changes will usually be introduced to achieve the desired outcomes, rather than repeating past performance.
Budgeting and the cash flow
A cash flow budget is a plan for future cash flow, addressing what the managers would like to see. Action will be taken to create a budget that will bring about the desired outcome, like having a healthier cash flow. Plans may be made to reduce debt and expenditure, while aiming to generate higher sales volumes and collect outstanding debt.
Budgeting is an essential tool for any business. If you would like more information about budgeting and your cash flow, please contact us to arrange an informal meeting.