Setting budgets

By the end of this unit you should understand:

the differences between income, expenditure and profits budgets

why businesses set budgets the ways in which businesses set

budgets the problems businesses encounter

when setting budgets.

Types of budgets

o A budget is a financial plan.o Sales revenue or earnings budgets. These set

out the business’s expected revenue from selling its products.

o Expenditure budgets. These set out the expected monthly expenditure on fuel, labour, telephone and similar charges.

o Profit budgets. By combining sales revenue and expenditure budgets it is possible to calculate expected profits. For many new businesses it may be that a profit is not made during the first months or even years of trading.

The process of drawing up budgets

o Forecast likely sales by using techniques such as market research. This allows the sales budget to be drawn up.

o Estimate costs associated with that level of sales. This gives the expenditure budget.

o Profit budgets. By combining sales revenue and expenditure budgets it is possible to calculate expected profits. For many new businesses it may be that a profit is not made during the first months of trading.

Why do businesses draw up budgets?

o Budgets help to ensure that a business does not spend more than it should.

o Budgets act as targets for entrepreneurs - a sales revenue budget can encourage employees to increase sales

o Setting budgets makes entrepreneurs think about the factors at work in the market (such as trends in consumers’ tastes) and how the business may respond to them.

Difficulties in setting budgets

o It may be difficult to forecast sales accurately. For a new business this is a particular problem as there are no trading records on which to base forecasts.

o The danger of unexpected changes. An entrepreneur may face an unforeseen rise in costs – for example, the 30% rise in fuel costs during 2006.

o Decisions by other organisations. Changes in interest rates can make it difficult to set accurate budgets.

o Using entrepreneurs’ time effectively. Setting budgets can be a time consuming task, especially for a new business

Sources of information for budgetso Similar businesses. A small business

from a different geographical area might discuss sales figures and costs as the new business is not a competitor.

o Professional organisations. Organisations representing the industry may offer advice on sales and costs.

o Bank and government organisations. Banks and organisations such as Business Link can provide help with budgeting.

Quick questions Is the following statement true or false? “Sales

volume and average selling price are the key pieces of information needed to construct an expenditure budget.”

 Drawing up budgets involves a series of activities. Place the four statements below in the correct order.

a) Draw up production budgets.b)Construct sales budgets.c) Establish the business’s objectives.d)Analyse markets and previous budgets to gather

information.

Quick questions

 Complete the following sentence: “A …………………… budget is constructed first because it gives an indication of likely …………...... on raw materials, wages and other costs.”

Of what is the following a definition? “A person responsible for the use and management of a particular budget.”

State two reasons why a newly created business should draw up sales and expenditure budgets.

Quick questions

 Complete the following sentence: “Entrepreneurs find it difficult to ...... sales revenue budgets because there are no .................... on which to base forecasts.”

 List three reasons why a new bakery may be unable to accurately forecast its sales during its first year of trading.

 Is the following statement true or false? “An unexpected rise in the rate of interest may increase the costs of a small business and make its expenditure budget inaccurate.”

Quick questions Of what is the following a definition?

“.......... exist when budgets are automatically set at nil and budget holders have to argue their case to receive any funds.”

Is the following statement true or false? “Setting budgets can be more difficult for new businesses than for established businesses.”