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3.9 Budgeting-

A budget is a financial plan that outlines expected costs and revenues to help businesses achieve their objectives and avoid failure. Cost centers are divisions responsible for their own operational costs, while profit centers are accountable for both costs and revenues, facilitating better management and accountability. Variance analysis compares planned versus actual expenditures to measure budgetary success and helps organizations monitor performance and control costs.

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10 views26 pages

3.9 Budgeting-

A budget is a financial plan that outlines expected costs and revenues to help businesses achieve their objectives and avoid failure. Cost centers are divisions responsible for their own operational costs, while profit centers are accountable for both costs and revenues, facilitating better management and accountability. Variance analysis compares planned versus actual expenditures to measure budgetary success and helps organizations monitor performance and control costs.

Uploaded by

advithivourkonda
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We take content rights seriously. If you suspect this is your content, claim it here.
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Budget

• A budget is a detailed financial


plan for the future, usually
involving the expected costs
and revenues or a cash flow
forecast, for a pre-determined
period of time.
• A budget is produced in order
to help a business to achieve
its organizational objectives.
Budgeting does not guarantee
success, but it can certainly
help to avoid business failure.
To assist the planning process

To communicate plans

Importan
ce of To coordinate activities and ensure harmony
between different departments of an organization

budget To motivate

To control and evaluate performance


Ways of setting Budgets

AVAILABLE HISTORICAL DATA ORGANIZATIONAL BENCHMARKING NEGOTIATIONS


FINANCE OBJECTIVES
Cost center

• A cost centre is a division of a business that has responsibility for


its own operational costs. The cost centre is held accountable for its
departmental expenditure. They can help managers to collect and
use cost data effectively, thereby having better budgetary control.
• For example, they may be held accountable for their own
expenditure on advertising, wages, and material costs. Cost centers
do not specifically generate any revenue, but their operations
contribute to the overall costs of the organization.
Cost centre
• Cost centres do not specifically generate any revenue but their
operations contribute to the overall costs of the organization.
For instance, most IB World Schools operate with cost centres,
such as the Science and Mathematics departments having
responsibilities for their own spending. Non-profit organizations
also tend to use cost centres for improved budgetary and cost
control.
Examples of cost centres in the corporate
world include:
• Customer service
• Finance
• Human resources
• Legal
• Marketing
• Production
• Purchasing
• Research and development (R&D)
• Technical support
• https://www.youtube.com/watch?v=CF989VgsYvI
Profit center
• A profit centre is a division of a business that has responsibility for
both costs and revenues generated within the department. Hence,
each profit centre is held accountable for the amount of profit made.
Large organizations tend to use profit centre to account for the
different amounts of profit made by different divisions the organization.
• For example, chain stores (with multiple outlets) hold each branch
(store) accountable its own profits or losses. Profit centres are
common in organizations that are decentralised. Operating profit
centres enables senior management to focus on strategic issues for
the organization, leaving the tactical issues to be tackled by
operational managers.
Example of profit centers
• At the retailer Walmart, different departments selling different
products could be divided into profit centers for analysis. For
example, clothing could be considered one profit center while home
goods could be a second profit center. In addition, departments that
rotate on a seasonal basis, such as the garden center or sections
relating to holiday decor, can be examined as profit centers to
separate these departments' seasonal contribution from those with
a year-round contribution.
• https://www.youtube.com/watch?v=mi-GrnO280E
Better monitoring and control.

Increase accountability, Budget vs Actual.


Merits of
cost Increase efficiency – Easier to pin point
which will lead to increase profits

centers Easier trouble shooting.

Easier to measure performance.


Reduces flexibility and process
improvement in a company.

Restriction on innovation.
Demerits
of cost Requirement of skillful personnel to set
standards.

centers Expensive

Not applicable to many businesses


Merits of profit
center
• Advantages of the profit centers are as
follows: The profit center helps in devising
strategies for low performing units by
allocating resources, increasing or
increasing revenues. When management
focuses on the revenue-generating capacity
of a particular unit it leads to an increase in
its overall productivity.
In practice, it may be difficult to allocate
costs to a particular division / centre.

Demerits
of profit Cost and profit centres may add to
pressures and stress on staff.

center Senior managers may be unable to


recognise whether a cost or profit centre
is running effectively / ineffectively.
Construction of budget
Variance
analysis
Variance analysis
• A variance refers to a discrepancy between the planned
(budgeted) item of expenditure or revenue and the actual
amount. For example, if Warner Bros planned to spend $150m
on producing a Hollywood movie, but ended up spending
$180m, then there would be a variance of $30m. Similarly, if
Foxconn, Taiwan’s largest manufacturer, planned to produce
50m smartphones but higher than expected sales meant it
needed to produce 60m units, there would be a variance of 10m
smartphones.
• Variances can are categorized as favourable
variances or adverse variances. Favourable variance occur
when profits are higher than expected (due to lower than
expected costs and/or higher than predicted revenues).
• Adverse variances occur when profits are lower than expected.
This is due to costs being higher than expected and/or
revenues being lower than predicted
Variance analysis
• Variance analysis (comparing planned and actual costs and
revenues) gives a benchmark for businesses to measure and
compare the degree of budgetary success. By measuring
variances, on a regular basis, budget holders can monitor and
control their costs and/or revenues in order to meet
organizational goals.
Q&A

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