University of Strathclyde – MBA CBFS

Budgeting

Prepared & Presented By

Ahamed Shamlee Hasheem
(BBA, ACMA, ASCMA, ACIM)

Additional Notes 1
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University of Strathclyde – MBA CBFS

Budget Theory

A budget is a quantitative expression of a plan of action prepared in advance of the period to

which it relates. Budgets set out the costs and revenues that are expected to be incurred or earned
in future periods.

For example, if you are planning to take a holiday, you will probably have a budgeted amount
that you can spend. This budget will determine where you go and for how long.

Most organisations prepare budgets for the business as a whole. The following budgets may also
be prepared by organisations:

– Departmental budgets.
– Functional budgets (for sales, production, expenditure and so on).
– Income statements (in order to determine the expected future profits).
– Cash budgets (in order to determine future cash flows).

Purposes of budgeting

The main aims of budgeting are as follows:

• Planning for the future – in line with the objectives of the organisation.
• Controlling costs – by comparing the plan of the budget with the actual results and
investigating significant differences between the two.
• Co-ordination of the different activities of the business by ensuring that managers are
working towards the same common goal (as stated in the budget).
• Communication – budgets communicate the targets of the organisation to individual
managers.
• Motivation – budgets can motivate managers by encouraging them to beat targets or
budgets set at the beginning of the budget period. Bonuses are often based on ‘beating
budgets’. Budgets, if badly set, can also de-motivate employees.
• Evaluation – the performance of managers is often judged by looking at how well the
manager has performed ‘against budget’.
• Authorization – budgets act as a form of authorization of expenditure.

Additional Notes 2
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University of Strathclyde – MBA CBFS

How are budgets prepared?

Before any budgets can be prepared, the long-term objectives of an organisation must be defined
so that the budgets prepared are working towards the goals of the business. Once this has been
done, the budget committee can be formed, the budget manual can be produced and the limiting
factor can be identified.

• Budget committee is formed – a typical budget committee is made up of the chief

executive, budget officer (management accountant) and departmental or functional heads
(sales manager, purchasing manager, production manager and so on). The budget
committee is responsible for communicating policy guidelines to the people who prepare
the budgets and for setting and approving budgets.

• Budget manual is produced – an organisation’s budget manual sets out instructions

relating to the preparation and use of budgets. It also gives details of the responsibilities
of those involved in the budgeting process, including an organisation chart and a list of
budget holders.

• Limiting factor is identified – in budgeting, the limiting factor is known as the principal
budget factor. Generally there will be one factor that will limit the activity of an
organisation in a given period. It is usually sales that limit an organisation’s performance,
but it could be anything else, for example, the availability of special labour skills.

If sales is the principal budget factor, then the sales budget must be produced first.

• Final steps in the budget process – once the budget relating to the limiting factor has
been produced then the managers responsible for the other budgets can produce them.
The entire budget preparation process may take several weeks or months to complete.
The final stages are as follows.

o Initial budgets are prepared.

o Initial budgets are reviewed and integrated into the complete budget system.
o After any necessary adjustments are made to initial budgets, they are accepted and
the master budget is prepared (budgeted income statement, balance sheet and cash
flow).
o This master budget is then shown to top management for final approval.
o Budgets are reviewed regularly.

Comparisons between budgets and actual results are carried out and any differences arising
are known as variances.

Additional Notes 3
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University of Strathclyde – MBA CBFS

Additional Notes 4
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