5.3.3 Budget statements
A budget provides a check on past performance against intended past performance and an estimate of future performance that can be monitored. A budget is usually detailed on a monthly basis – usually for at least a year forward, with the past year for comparison.
A budget is used to answer two questions.
- How have we performed compared to our expected performance?
- How do we expect to perform in the future?
A budget can take many formats, but where (as in Hannah’s case) a cash flow is projected forwards for 12 months, this can become the basis for the budget.
As well as the financial figures in the budget, other statistics, such as output in units and staff turnover, can be included as a forecast and a measure of past performance. The difference between what was intended and what is actually achieved is called a variance and an examination of variances together with identification of their causes is an essential management tool. Variances point the way to corrections by management that can keep the organisation on course for success.
Case study: Catterline – creating a budget
By taking the spreadsheet calculations forwards to June of Year 2, Hannah is, in effect, creating a budget. She is stating what she expects revenue and outgoings to be. A budget enables Hannah to plan for the future – particularly if she carries out ‘what if’ calculations (in effect ‘flexing’ the budget). The budget can also enable her to judge her performance in the past and identify where the actual results varied from what was expected (‘variances’). For this to happen the cash-flow and profit-and-loss spreadsheets need to be updated with actual figures at the end of each month. Hannah does this at the end of June in Year 1. Her profit-and-loss looks like this Profit and loss budget.
Hannah prints out her cash flow and profit-and-loss each month and keeps them in a folder. She can easily compare what she thought would happen in June to what actually did happen. There is a variance on the assemblers’ costs and the occupancy costs. This has increased the cash flow deficit by £1,200. An investigation indicates that an assembler was off sick and the others had to work overtime to keep up production. The overtime required extra electricity, pushing up the occupancy costs. Hannah has identified the variance in her budget and found out the reason, and can now easily see what the decision to work overtime actually cost the company.
Task 40: Budget for first-year trading spreadsheet
Review the assessments you have made so far about your resource needs. Taking into account your projected profit-and-loss account, use your spreadsheet to construct a budget for your first year of trading that will enable you to monitor your progress.