Past Budgets Of A Business Unit Are Analysed To Forecast Budget Need

In preparing budgets, we need to set realistic financial objectives and assumptions for the new accounting/budgeting period. To do this a business must first have a close look at its history. In this way opportunities for improvement can be identified and built into the budget.

The Income Statement and the Balance Sheet are the two financial statements that you need to set sound objectives for your budget.

Let’s have a look at the methods you can use for analysis. They are:

• Horizontal Analysis
• Trend Analysis
• Vertical Analysis
• Ratio Analysis

Let’s consider each of these in turn:

Horizontal Analysis involves studying changes in each line of the budget to find out how it changed from one period to the next. It is important to find out why it changed and whether the change was favourable or unfavourable.

Click here to view a video that explains Horizontal Analysis.

Trend Analysis involves the changes over a longer period; three to five years and is presented in either rand value or as a percentage. It should be noted though, that this analysis can be misleading. For instance, sales may increase in value through market forces – price increases due to inflation or the increase may be a once-off situation due to market growth. If the reason for the distorting variances is known, the value should be reduced to its base year value before these percentages are calculated. Have a look at the example below:

Click here to view a video that explains Horizontal or Trend Analysis.

Vertical Analysis shows the relationships between items in the same budget period. This is in contrast to both Horizontal and Trend Analysis where one item over a period of time is looked at. This type of analysis serves to analyse a company’s performance by comparing the current year’s data with that of the previous years.

Click here to view a video that explains Vertical Analysis.

Ratio Analysis allows you to compare relationships between a number of items from the Income Statement or the Balance Sheet so that areas that need attention can be identified.

Your company’s performance over previous accounting periods can also be analysed. There are a number of ratios that can be used; no single ratio will give you the whole story, so it is best to calculate the key ratios. This way you can use them to analyse the whole situation.