Topics: Balance sheet, Budget, Income statement Pages: 10 (2411 words) Published: December 11, 2012
Financial Modelling CHAPTER 3: BUDGETING
The difference between a forecast and a budget
A business forecast is an estimate of the likely position of a business in the future, based on past or present conditions. However, a budget is a statement of planned future results which are expected to follow from actions taken by management to change the present circumstances. Budgets as tools for planning and control

Managers are responsible for planning and controlling a business for the benefit of its owners, and budgets are essential tools for planning and controlling. Well-managed businesses have short-term budgets for, say, the year ahead. Small businesses may function well enough with these, but larger businesses need to plan further ahead and prepare long-term budgets, in addition to the short-term ones, for the next five, ten or even more years ahead. These plans are often known as rolling budgets because, as each year passes, it is deleted from the budget and a budget for another year is added. A budget for one year ahead will be detailed, but budgets for the following years may be less precise because of uncertainty about future trading conditions. The manager of each department or function in a business is responsible for the performance of his or her department or function. Separate operational, or functional, budgets must be prepared for each department or activity detailing the department’s revenue (if any) and expenses for a given period. The budgets will be prepared for sales, production, purchasing, personnel, administration, treasury (cash and banking), etc. opinions differ as to who should prepare these budgets. Top-down budgets are prepared by top management and handed down to departmental managers, who are responsible for putting them into effect. Such budgets usually have the merit of being well coordinated so that they all fit together as a logical and consistent plan for the whole business. However, departmental managers may not feel committed to keeping to these budgets as they have little or no say in their preparation and may be of the opinion that the budgets are unrealistic. Bottom-up budgets are prepared by departmental managers and may be unsatisfactory because: * They may not fit together with all the other departmental budgets to make a logical and consistent overall plan for the business * Managers tend to base their own budgets on easily achievable targets to avoid being criticized for failing to meet them; this will result in departments performing below their maximum level of efficiency and be bad for the business as a whole.

A budget committee, which should include an accountant, should coordinate the departmental budgets to ensure that they achieve top management’s plans for the business. The benefits of budgets may be summarized as follows:-

1. They are formal statements in quantitative and financial terms of management plans. 2. Their preparation ensures the coordination of all the activities of a business. 3. When managers are involved in the preparation of their budgets, they are committed to meeting them. 4. Budgets are a form of responsibility accounting as they identify the managers who are responsible for implementing the various aspects of the overall plan for the business.

Control involves measuring actual performance, comparing it with the budget and taking corrective action to bring actual performance into line with the budget. It is important that deviations from budget are discovered early before serious situations arise. Annual departmental budgets are broken down into four-weekly or monthly, or even weekly, periods, and departmental management accounts are prepared for those periods. These management accounts compare actual performance with budget and must be prepared promptly after the end of each period if they are to be useful. If actual revenue and expenditure are better than budget, the differences (or variances) are described...
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