Budgeting in business

A budget is a financial plan. Specifically, a budget sets forth management's expectationsfor revenues and, based on those financial expectations, allocates the use of specific resources throughout the firm. You may live under a carefully constructed budget of your own. A business operates in the same way. A budget becomes the primary basis and guide for financial operations in the firm.

Budgeting is the principle activity in the planning function that all managers of successful firms must do in order to meet desired results. Just as managers use forecasts to approximate income from sales, they must also forecast the future availability of major resources, including people, raw materials, energy, and money. Techniques for forecasting resources are the same as those employed to forecast sales: hunches, market surveys, time-series analysis, and econometric models. The only difference is that the manger is seeking to know the quantities and prices of goods that can be purchased rather than those to be sold. A very close relationship exists between budgeting as a planning technique and budgeting as a control technique. During the planning phase of management, firms forecast future allocations of resources for business activities. After the organization bas been engaged in activities for a time, actual results are compared with the budgeted (planned) results and may lead to corrective action. This is the management function of controlling.

The budgeting process is complex in nature, derived from the management's objectives for the organization to the final financial budgeted balance sheet formulated. Sales forecasts play a key role in the budgeting process. It consists of a forecast of quantities sold and forecast of dollar income expected. All other budgets are related to it either directly or indirectly. The production budget, for example, must specify the materials. labour, and other manufacturing expenses required to support the projected sales level. Similarly, the marketing expense budget details the costs associated with the level of sales activity projected for each product in each sales region. Administrative expenses also must be related to the predicted sales volume. The projected sales and expenses are combined in the financial budgets, which consist of pro forma financial statements,inventory budgets, and the capital additions budget.

Most firms compile yearly budgets from short-term and long-term financial forecasts. There are usually several budgets established in a firm:

· An operating budget

· A capital budget

· A cash budget

· A master budget

Forecast data are based on assumptions about the future. If these assumptions prove wrong, the budgets are inadequate. So the usefulness of financial budgets depends mainly on the degree to which they are flexible to changes in conditions. Two principle means exist to provide flexibility: variable budgeting and moving budgeting. Variable budgeting provides for the possibility that actual output changes from planned output. It recognizes that variable costs are related to output, while fixed costs are unrelated to output. Thus, if actual output is 20 percent less than planned output, it does not follow that actual profit will be 20 percent less than that planned. Rather, the actual profit varies, depending on the complex relationship between costs and output. Furthermore. moving budgeting is the preparation of a budget for a fixed period (say, one year), with periodic updating at fixed intervals (such as one month). For example, a budget is prepared in December for the next 12 months, January through December. At the end of January, the budget is revised and projected for the next 12 months, February through January. In this manner, the most recent information is included in the budgeting process. Premises and assumptions are constantly being revised as management learns from experience.

In addition, budgets can sometimes lead companies to overlook critical variables such as quality and customer service. Often, their decision-making process is based solely on numbers and dollars, and wrong moves can turn into lost profit. To combat this companies set up guidelines that include the necessity to plan first, budget later: budget for managers, not accountants: measure output, not input; and design budgets to protect against dispute between departments.

Budgets are an important activity crucial to a managers’ success in maintaining the bottom line of a company. Without them, it would be the equivalent to walking through a mine field without sight. Eventually, you're going to be blown out of the way by competing firms.

QUESTIONS

1. What is a budget and what is it based on?

2. Why do sales forecasts play a key role in the budgeting process?

3. What are the components of the budgeting process?

4. How many kinds of budgets do you know? What are they?

5. Describe the two principle means providing flexibility: variable budgeting and moving budgeting.

6. Is there any difference between a budget and a financial plan?

7. What is the importance of making a budget?

to destock – to cut or use stocks to annualize – to calculate over a period of year to shrink – to become smaller in amount, size, or value to slide into recession – to gradually start to experience decrease in economy and employment economic slowdown – time or period when economic development gets slow