BAFS Study Notes: Budgeting

Hello! Welcome to your study notes on Budgeting. Think of a budget as a company's financial game plan. It’s a crucial tool for any business, big or small. In this chapter, we'll explore what budgets are, why they're so important, and how businesses use them to stay on track. Don't worry if this sounds complicated; we'll break it down with simple examples you can relate to!


1. What is Budgeting and Why Bother? (Purposes of Budgeting)

A budget is a financial plan for a future period, usually one year. It estimates a company's expected income and expenses. Think of it like planning a big party with your friends. You estimate how much money you'll have (income) and then plan how much to spend on food, drinks, and decorations (expenses) so you don't run out of cash!

Businesses create budgets for several important reasons. Here's a simple way to remember them with the mnemonic P-C-M-C:

P - Planning

A budget forces a company to think ahead and set clear goals. It answers questions like, "How much do we want to sell next year?" and "How much can we afford to spend on advertising to reach that goal?"

  • In simple terms: It's like creating a roadmap for a journey. You decide your destination (goal) and plan the route (actions) before you start driving.
  • Example: A cafe owner creates a budget to plan for opening a new branch next year. The budget will include the estimated costs of rent, renovation, and new staff, as well as the expected sales from the new location.
C - Coordinating Activities

Most businesses have different departments (like Sales, Marketing, Production). A budget ensures everyone is working together towards the same company-wide goals. The sales department's target must match what the production department can actually make!

  • In simple terms: It’s like a conductor leading an orchestra. The budget makes sure all departments (the musicians) are playing in harmony.
  • Example: The marketing department is budgeted $50,000 for a campaign to increase sales by 10%. The production department's budget is then increased to buy enough raw materials to produce 10% more products.
M - Motivating Staff

A well-designed budget gives managers and employees clear, achievable targets. When people know what's expected of them, and the goal is realistic, it can be a powerful motivator. Meeting or beating the budget can lead to bonuses and recognition!

  • In simple terms: It’s like a target in a game. Having a clear target to aim for makes the game more focused and exciting.
  • Example: A sales team is given a budget target to sell 1,000 units per month. If they achieve it, they get a team bonus.
C - Controlling and Evaluating Performance

This is one of the most important functions! After a period (e.g., a month or a quarter), managers can compare the actual results with the budgeted figures. This helps them see what went right and what went wrong.

  • In simple terms: It’s like checking your report card. You compare your actual grades with your target grades to see where you need to improve.
  • Example: A company budgeted $10,000 for electricity but actually spent $12,000. By comparing the actual cost to the budget, management can investigate why they overspent. Maybe they need more energy-efficient lights.
Key Takeaway for Section 1

Budgeting isn't just about numbers; it's a key management tool for Planning, Coordinating, Motivating, and Controlling.


2. Budgetary Control: The Good vs. The Bad

Budgetary control is the whole process of creating a budget, comparing it to the actual results, and then taking action to correct any differences. It's the "control" part we just talked about. Let's look at its usefulness and its limitations.

Usefulness of Budgetary Control (The Good Stuff 👍)
  • Identifies Problems Early: By regularly checking performance against the budget, managers can spot issues (like costs being too high) before they become major disasters.
  • Improves Decision-Making: It provides managers with valuable information, helping them make smarter, more informed decisions.
  • Assigns Responsibility: It makes it clear which manager is responsible for which part of the budget. This increases accountability. (e.g., The Marketing Manager is responsible for the advertising budget).
  • Improves Communication: Creating a budget requires departments to talk to each other, improving coordination and understanding across the company.
  • Encourages Forward Thinking: It forces managers to think about the future, not just the day-to-day problems.
Limitations of Budgetary Control (The Not-So-Good Stuff 👎)
  • Time-Consuming and Costly: Preparing a detailed budget for a large company takes a lot of time, effort, and staff resources.
  • Can Become Outdated: Business environments can change quickly (e.g., a sudden increase in the price of raw materials). A budget created six months ago might become unrealistic.
  • Can Cause Conflict: Departments might argue with each other to get a bigger share of the limited resources, leading to internal politics and resentment.
  • May Stifle Initiative: Some managers might stick too rigidly to the budget and refuse to spend money on a great, unexpected opportunity because it wasn't planned for.
  • Demotivating if Unrealistic: If the budget targets are set too high and are impossible to achieve, it can discourage and demotivate employees instead of motivating them.
Quick Review Box

Budgetary Control is Useful because... it helps find problems, make good decisions, and assign responsibility.
But it has Limitations because... it can be costly, outdated, cause conflicts, and be demotivating if done poorly.


3. When Things Don't Go to Plan: Budget Variances

Okay, so you've made your plan (the budget), and now you're looking at what actually happened (the actual results). The difference between the two is called a variance.

Super Important Note for HKDSE: You only need to understand what a variance is, what causes it, and how to fix it. You DO NOT need to calculate variances for the exam!

A variance can be good news or bad news.

  • Favourable Variance (Good News 🎉): When the actual result is better than the budget.
    Example: Actual costs are LOWER than budgeted, or actual sales are HIGHER than budgeted.
  • Adverse / Unfavourable Variance (Bad News 😟): When the actual result is worse than the budget.
    Example: Actual costs are HIGHER than budgeted, or actual sales are LOWER than budgeted.
Identifying the Causes of Variances

Just knowing there's a variance isn't enough. A good manager must investigate why it happened. Let's look at some common causes.

Possible Causes for Sales Variances:

  • Higher or lower selling price: The company decided to increase its price or had to offer unexpected discounts.
  • Sales volume changes: The company sold more or fewer units than planned.
  • Marketing effectiveness: An advertising campaign was more (or less) successful than expected.
  • Competition: A new competitor entered the market and took some of your customers.
  • Economic conditions: The economy is booming (people have more money to spend) or is in a recession.

Possible Causes for Cost Variances:

  • Changes in material prices: The cost of raw materials from a supplier went up or down.
  • Changes in labour wages: The company had to pay workers more, perhaps due to unexpected overtime.
    • -Efficiency or Wastage: Workers were more efficient and used fewer materials than planned (favourable), or there was more wastage than expected (adverse).
  • Unexpected Expenses: A machine broke down and needed expensive, unplanned repairs.
Proposing Remedial Action (How to Fix It!)

After finding the cause, managers need to take remedial action. The action should match the cause.

Scenario: There is an adverse sales variance (sales were lower than budgeted).

  • If the cause is... a new competitor, the action could be... to launch a new marketing campaign, improve the product, or adjust the price.
  • If the cause is... an ineffective advertising campaign, the action could be... to review the marketing strategy or hire a new advertising agency.

Scenario: There is an adverse material cost variance (material costs were higher than budgeted).

  • If the cause is... a supplier increasing their price, the action could be... to negotiate a better price or search for a new, cheaper supplier (while ensuring quality is not compromised!).
  • If the cause is... high wastage of materials, the action could be... to provide better training for employees on how to handle the materials more carefully.
Did You Know?

Investigating variances is sometimes called 'management by exception'. This means managers focus their attention only on the areas where results are significantly different from the plan (the 'exceptions'), saving them time and effort!

Common Mistakes to Avoid

A common mistake is proposing a solution without investigating the cause. For example, if sales are low, just saying "increase advertising" might be wrong. What if the problem is actually that your product quality has dropped? You must first identify the cause, then propose a suitable remedial action.

Key Takeaway for Section 3

A variance is the difference between budget and actual results. It can be favourable (good) or adverse (bad). The key management skill is to identify the cause of the variance and then propose a specific remedial action to fix the problem.