Budgeting: planning, forecasting, control and the budget process

Why budget?

• Planning: forces managers to think ahead about targets and resources.
• Forecasting: estimates future revenue, costs and cash, so shortages can be foreseen (for example arranging an overdraft early).
• Coordination: sales, production, purchasing and finance plans fit together.
• Communication: everyone knows the targets.
• Control: actual results are compared with the budget; variances are investigated and corrective action taken (budgetary control).
• Motivation and responsibility: managers are accountable for their own budget centres.

The budget process

1. Set objectives for the period.

2. Identify the principal budget factor (limiting factor): the thing that limits activity, usually sales demand.

3. Prepare the budget for that factor first, normally the sales (revenue) budget.

4. Prepare the functional budgets that follow from it: production, purchases (materials), labour, overheads, inventory.

5. Prepare the receivables, payables, capital and cash budgets.

6. Combine them in the master budget: budgeted statement of profit or loss and statement of financial position.

7. Review and approve (a budget committee coordinates, a budget manual sets the procedures).

8. Monitor: compare actual with budget each month and act.

Participation and limitations

• Participative (bottom-up) budgets involve managers, improving motivation and using local knowledge, but take longer and invite 'budgetary slack'.
• Imposed (top-down) budgets are quicker but may demotivate.

Limitations: based on estimates (new businesses have no past data, so budgets may be guesswork), can be rigid if conditions change, may encourage spending up to the limit, and time-consuming to prepare.

Worked example

A furniture maker can sell 12,000 tables but its factory can make only 9,000. What is the principal budget factor and which budget should be prepared first?

1. Demand exceeds capacity, so production capacity limits activity
2. The principal budget factor is production capacity (9,000 tables)
3. The sales budget is then set at what can be produced, and production planning comes first

Answer: Production capacity is the principal budget factor; plan around 9,000 tables

Check yourself

1. What is the principal budget factor?
   • The largest expense in the budget
   • The person who prepares the budget
   • The budgeted profit
   • The factor that limits the activity of the business, so it is budgeted first
   Show answer

   The factor that limits the activity of the business, so it is budgeted first. It limits activity, so all other budgets depend on it; usually sales demand.

2. In most businesses, which budget is prepared first?
   • Cash budget
   • Sales (revenue) budget
   • Budgeted statement of financial position
   • Capital budget
   Show answer

   Sales (revenue) budget. Sales demand is usually the principal budget factor.

3. What is budgetary control?
   • Preparing next year's budget
   • Setting the share price
   • Auditing the accounts
   • Comparing actual results with the budget and taking action on variances
   Show answer

   Comparing actual results with the budget and taking action on variances. Control means monitoring and corrective action.

4. What does the master budget contain?
   • The budgeted statement of profit or loss and statement of financial position
   • Only the cash budget
   • Only the sales budget
   • The previous year's actual results
   Show answer

   The budgeted statement of profit or loss and statement of financial position. The master budget summarises all functional budgets.

5. Which is an advantage of participative budgeting?
   • It is always quicker
   • It removes the need for a budget committee
   • Managers who help set targets are more motivated to achieve them
   • It guarantees accurate forecasts
   Show answer

   Managers who help set targets are more motivated to achieve them. Involvement increases ownership and uses local knowledge.

6. Explain one problem a newly formed company faces when preparing budgets.
   Show answer

   It has no past (historical) data to base its forecasts on, so figures are estimates or guesswork and may be inaccurate.. Without past results, budgets for a new company rest on assumptions; examiners rewarded this point in applied answers.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (XAC11/YAC11), Issue 2
• Pearson Edexcel IAL Accounting WAC12 examiners' report, October 2022

Last updated 8 November 2026. Spotted a mistake? Tell us.