What is Budgeting?
Budgeting is nothing but planning finances in advance for a defined period. Planning finances allows an individual or a company to stay within expenditure limits.
Budgets are not limited to business entities alone. Individuals, families, government, and corporates also have their budgets, usually for a pre-defined period. In a nutshell, budgeting is balancing the expenditure with the income.
Types of Budgeting
Budgeting is an essential part of running a business. It helps track the resources the company will utilize and establishes a spending plan for efficiently running the business. A business starts budgeting with the budget development process.
At the start of the process, expected sales trends, cash flows, market outlook, etc., are assumed for the target budgeting period. Details of specific factors that might affect the sales or lead to more expenses are projected. The guidelines followed, reasons for specific calculations, how the assumptions on future market conditions were made, etc., are included in the budget documents.
A corporate budget begins with the preparation of the sales budget. Without the projections of how sales are going to be assuming cash flows will be difficult. It is why sales trends are projected and budgeted first.
Within a large organization, budgets are prepared individually for the subsidiaries, various departments or divisions, etc. All these budgets are included in the final master budget.
In the master budget, cash inflow and outflow projections, financial statements, and the overall financing plan are detailed. The higher management of an organization reviews the budget and places it before the board of directors for approval.
Types of Budget
Corporations use the following types of budgets to forecast their numbers.
In this budget, the overall expenditure plan, along with financial statements for the whole company, is prepared. It contains projections such as revenue, income, sales, operating costs, etc.
It is the first budget a corporation prepares. The static budget determines the actual cash available with the corporation based on which it develops an expenditure plan. Income and expenditure projections for all the divisions of the corporation are prepared in this budget. It majorly deals with all fixed expenses.
In this, the day-to-day operating finances such as the revenue generated and expenditure incurred are budgeted. It focuses on the costs of goods sold (COGS) in producing a good or service and income through sales. Long-term debt and capital expenditure are not included in the operating budget.
Cash outflows and inflows are budgeted with a cash-flow budget. Managers use this budget to assess the cash flow projections for the period and can make decisions like applying for a short-term or long-term line of credit with banks.
Why is Budgeting Important?
Budgeting is considered an essential and integral part of businesses. A business without a budget may not be able to cope up with day to day unexpected expenses and issues. Allocating budget is a sensible approach to review the business, financial position, and performance of the company.
A budget helps in identifying the available resources, minimizing the expenditures, and predicts the income flow.
Some of the benefits of budgets are as follows-
- Budgeting helps in allocating the funds to those areas, which indicates the growth of the businesses.
- Budgeting helps in meeting the long term objectives of the company.
- When budget and actuals are compared, it indicates the financial status of the organization.
A business with a vision without a budget is like trying to reach a destination without a roadmap.