Question

Why do companies create/use a budget in general? What are the advantages? Then also think a little outside of this video....think about big, multinational companies as well. Why do large companies use budgets?

Answer 1

Hi,

A Budget is a financial tool used to plan and forcast future income or expenses for a specified period of time , considering various external factors (eg. Industry trend, Economic conditions, Corporate laws and regulations) and internal factors ( Reliability of internal controls of the organisation, [ Nature of management - whether their approach is conservative or aggressive) . For a budget to be useful, it must be quantified in terms of money or quantity. A budget is used to set standards or targets which are compared with actuals, to analyze whether the actuals meet the standards set by the budget. For example, in terms of expenditure, A Budget is planned expenditure [(eg) Purchase plan - Purchase 1000 kg of Raw material @ Rs. 10/- per kg ] . Actuals is Actual expenditure incurred [(eg) Purchased 800 kg of Raw material @ Rs. 11/- per kg ] . Standard is Allowed expenditure, for Actual quantity [(eg) Allowed to Purchase 800 kg of Raw material @ Rs. 10/- per kg ] .

Companies,whether small or large, use a budget to have a control on the usage of their resources , to ensure that their resources are utilized in the most optimum manner by comparing the actuals with the budget standards,using the techniques of Standard costing analyzing the deviations between actuals and budget standards and taking appropriate corrective action to minimize unfavourable deviations [ (eg) Budgeted labour cost per hour was Rs. 20 , Actual labour cost per hour was Rs. 30 ]

Further, they help in fixing responsibilities on respective departments and appraising or cautioning the repective departments of an organisation. For example, 2 kgs of Raw material are allowed to be used in manufacturing 1 unit of output and the raw material is allowed to be purchased @ Rs. 12 per kg. The actuals state that 3 kg of Raw material was used to manufacture 1 unit of output and raw materials were purchased @ Rs. 10 per kg. In this case, Production manager is to be penalised for excessive usage of raw material , causing an unfavourable deviation and Purchase manager is to be appraised for purchasing raw material at lesser price than planned, causing a favourable deviation.

A solid budget identifies current available capital, estimates expenditures and anticipates revenues. Businesses should continually refer to them as a way of measuring performance against expectations.

Advantages of a budget are :

1. A budget is a blue print of the desired plan of action or operation. Plans covering the entire organization and all its functions like purchase, production, sales, financial management,etc.

2. The budget serves as a declaraton of policies amd also defines the obective for executives at all levels of management.

3. Budgets provide a means of co-ordination of the business as a whole. In the process of establishing budgets, the various factors like production capacity, sales possibilites and procurement of material,labour,etc are balanced and co-ordinated so that all the acitivities proceed according to the organizational objectives.

4. Budgets are a means of communication. Complex plans laid down by top management are passed on to those who are responsible for putting them into action.

5. Budgets facilitate centralized control with delegated authority & responsibility .

6. Budget are instruments of managerial control by means of which the management can measure performances in every part of the concern and take corrective action as soon as any deviation from the budgets come to light.

Hope it helps.