Unit 19: Budgets

Listen to the recording as you read the text. Then complete the activities.

Nobody likes the word 'budget' , but the truth is that without accurate budgeting and planning business could not exist. This is even more true in financial departments, such as accounting.

Budgets can represent one of the most important tools that a financial department has at their disposal, providing they are prepared in a realistic manner covering all areas of the business without errors of omission. One of the main benefits of a business budget is the ability to restrict and limit how much money is spent on a given operation. Budgets normally count expense accounts to make sure that capital is not being wasted on unneeded goods or that the company is not overpaying for materials used in the business. Limiting capital spent by the business may mean that owners and managers are forced to find new suppliers to acquire business inputs, thus saving money and meeting their budget.

Companies regularly go over budgets to plan future growth and expansion. Money saved on day-to-day business expenditures can be set aside in a special reserve account designated for future new business. Budgeting for future growth opportunities means that companies have the available capital when an opportunity to expand business operations presents itself.

Traditionally, budgets were seen as nothing more than a way to forecast the forthcoming years business activity. They were prepared by the owner, or a senior manager who had only a limited knowledge on the actual financial results and their effect. This meant that budgets were often highly inaccurate when compared to the actual results, and as such these managers ran into problems when using these budgets as a method of planning for the future.

On account of these problems, the process of budgeting is changing, and managers are making use of accounting professionals in the process of drawing up budgets. Accountants working together with senior management are able to accurately forecast the results of a given situation by using flexible or dynamic budgets which react to increases or decreases in sales to show the net effect on the company. This means that management are aware of possible marginal costs associated with production in any situation and show the margin of safety, which greatly helps in planning courses of action in case of a drop in sales.

Even in the case of a company having an adverse budget result, the process of budgeting can still prove useful. By comparing and contrasting the actual results with the budgeted results over the course of several years, it is possible to observe cyclical patterns which are likely to happen again and as such can then be predicted with a higher degree of accuracy.

However, it is not just financial accounting which makes use of budgets - they also feature heavily in management accounting, with the management accountant setting out various budgets for different purposes. In management accounting, these budgets act as a means of confirming assumptions and providing insight into strategic planning. Providing the budget is well-planned, the company may [go ahead] with its strategy with no surprises.

Nowhere is the importance of budgeting in accounting more visible than in the public sector, where a budget represents legal authority to carry out an action. Unlike the private sector, where success can be measured in profit, the public sector can only use comparisons of budgeted to actual figures to show financial success. In the public sector, budgets are referred to before any major decision can be made which means that correct budgeting practices must be maintained and while it may not be possible to eliminate mistakes entirely, every effort is taken to ensure that the budget is realistic and achievable.

Now continue to the Activities