Types of budgets and reasons for using them

This blog covers a number of budgets
Purchases

Production

Trade receivables

Trade payables

Cash budgets (Cash flow forecast)


Budgets are used for a variety of reasons

• To communicate the companies objectives, opportunities and plans to their managers.
• Make organisation aware of its future requirements (raw materials, staffing) to allow planning.
• Delegate responsibilities to managers for tasks / resources without losing control of overall objectives 
• Improve the company’s efficiency

Benefits of budgeting

• Management decisions can be linked to the company’s overall strategy.   
• Standards can be set to try to aid each areas performance.
• Plans can be set in financial terms so costs can be minimalised or possibly avoided entirely (overdraft fees, overtime or additional storage costs).
• Managers can be made responsible for budgets.
• Budgets encourage co-operation and co-ordination between departments.  For example the Production departments should be working closely with the sales department to avoid making items which may not be needed.
• Employees are motivated to achieve objectives which may help to reduce its wastage and reduce costs.  This may be financially encouraged via bonuses etc.
• Control of operations and activities - outcomes compared to the budget using variance analysis techniques.  This means each area can be evaluated in terms of its performance.

However they do have some disadvantages

• Budgets are only as good as the data being used.  If it is too hard to achieve the budget people give up.  If it is too easy to do and people do not need to be pushed hard to achieve them.
• Budgets need to change as circumstances change – but people may work towards their own specific targets rather than overall needs of the company.
• Managers can get too focussed with achieving the budget and forgetting to focus on the real issues of winning customers.  Sales of mortgages before the credit crunch focused on quantity of mortgages sold rather than the customers’ ability to repay.  Profitability suffered as a result.
• Budgeting is a time consuming process in itself costing money to set up and organise.
• Budgets constrains actions – people work to keep to their budget rather than the right long term decision which may exceed the budget but may benefit the company more overall.

Sales Budget

The sales budget should be the first budget created in order to enable an efficient business to work towards meeting customer demands.

Production Budget

The production budget is used to ensure the firm can meet the demands of the sales department.  They then know how many they need to make and why.  Note there will usually be a closing inventory to allow for additional sales.  However it may need to be flexible to avoid a build-up of inventory which could cause wastage.

 

Purchase Budget

If the firm is purchasing items it needs to ensure it has enough to meet demand but avoids any unnecessary wastage

 

Labour Budget

The labour budget enable managers to plan ahead to meet production.  It can be used to maximise efficiency by having staff available at the right times to meet demand and minimising overtime needs.

Trade Payables Budget 

Trade Receivables

 Cash Budget

This ties together all the budgets by putting the inflows and outflows (many of which were calculated in earlier budgets) together to help review the overall cash position of the firm.   Many budgets will include the net inflow for each month.   The figure are probably a lot bigger than this but the principle is the same! Cash budgets are discussed in more detail here.