Businesses use budgeting processes in order to plan how to allocate resources in different business areas. In many cases business may have different budgets for each division. For example, there may be different budget for sales department and different for production department. These are then combined into central budget usually called "master budget".
Budgets are power control tools to make comparisons between the original budgets and the actual performance. If there is a significant different then corrective actions must be taken. With budgets:
* managerial responsibilities are clearly defined,
* individual budgets lay out a specific plan of action,
* managers have the responsibility to adhere to their budgets once these have been approved,
* the actual performance is monitored constantly and compared with the budget,
* corrective actions are taken when there are significant differences between the budget and the actual performance,
* budgets are approved by senior management,
* variances should by thoroughly investigated if significant.
The budgeting process
The budget process starts from the definitions of the objectives and the determination of the period for which the budget is relevant. The usual budget period is one year. Additionally, the budget should be administered with someone with accounting functions.
A typical example of budgets and their relations is shown in the figure below:
Source: Dyson, J. R., 2010. Accounting for Non-Accounting students. FT Prentice Hall, pp.33
The budget consequences
Budgets have impact on the business divisions and its people. Dyson (2010) suggests that for a budgetary system to work the following should be present:
* Managers should be consulted on any proposal for budgeting system
* Managers should have some training to be aware of the importance of budgeting and budgetary control system
* Managers should be directly involved in any budgeting process that involves their area
* Managers should prepare their own budgets rather then having them impose on them
* Managers should not be disciplined for any variances unless they are guilty of negligence.
Forecasting
Financial information are used to access financial performance of a business. Forecasting is the financial activity that generally includes the 'profit and loss statement'. Ig generally shows:
Last year's actual results
Management will determine achievable results for the next year
Management and accounting will prepare a formal operating budget including financial goals by day, week, month and year outlining the financial goals for the next year
The budget will be approved and include monetary values, percentages and statistics and then distributed to all departments to use for the entire year
At the end of each month the accounting department will provide weekly breakout of the budget for each department
Each department will review budget for the next week. If there is no meaningful changes, the department will use the weekly budget as its weekly forecast and plan its next week - day to day - according to the budget numbers.
If there is a meaningful change - either increases or decrease - the department managers will update the budgets by making changes to reflect the business environment more accurately.
Forecasts are generally included in internal managerial reports. The forecasts can be weekly, monthly, quarterly, yearly or even longer. Predictions can be made based on past performance or as a result of special events
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