An old proverb says 'he who fails to plan, plans to fail'. Although not originally quoted in a business context it certainly holds true. Planning is one of the key roles of managers and business planning can provide frameworks for business operations. A financial plan is called a budget. Davis Service Group has attributed its ability to weather the recession, in part, to its effective budget setting, allowing it to remain profitable even during the period 2008-9 when many businesses suffered as a result of the economic downturn. Davis is a service based organisation which sources, cleans and maintains industrial textiles such as linens and protective clothing. It uses budgets to plan for the short and long term use of its resources as well as a communication tool to allow employees to understand where the business is heading. Davis understands that external factors can have an impact on whether it will be able to meet its budgets and therefore considers different scenarios during budget setting to allow for favourable or less favourable trading conditions.
Last week British Airways (BA) reported half year profits of £158 million. This is the first time it has reported a profit in two years. The Icelandic ash cloud and cabin crew strikes negatively affected BA during this time yet it still managed to turn a higher profit than analysts expected. During this period the organisation managed to cut costs by 1.5%. BA said that cost control was a continual focus and it no doubt used expenditure budgets to allow it to control and monitor its costs during this time. (BBC 29th October 2010)
- Define budget.
- List the different types of budgets that businesses may draw up.
- Explain the difficulties businesses may face when setting budgets.
- Analyse the advantages of setting budgets for organisations like Davis and BA.
Answers to questions
- Define budget. A budget is a forward financial plan.
- List the different types of budgets that businesses may draw up. Budgets may be drawn up for: Sales, Output, Costs, Profits, Cash flow, Capital investment.
- Explain the difficulties businesses may face when setting budgets. Difficulties may include: A lack of historical data on which to base budgets. The is often the case with new businesses or when firms have entered new markets. Time – setting budgets can be time consuming and therefore carries an opportunity cost. Difficulties predicting the future. External factors which are outside the control of the business can have an impact on whether budgets can be met e.g. the volcanic ash crisis for BA. Conflict – budgets may cause conflict between different departments or managers.
- Analyse the advantages of setting budgets for organisations like Davis and BA. Budgets aid control and monitoring of operations, allowing action to be taken at an early stage if budgets are not being met. Budgets can act as targets which may motivate staff. Budgets can provide a method of allocating and using resources. Setting and using budgets can promote forward thinking. Budgets can provide a framework for delegation.