What is Budgeting? Benefits-Process and Types

What is Budgeting? Benefits-Process and Types

What is budgeting?

Budgeting is essential to financial well-being. Being an student, you always budget your study time and your money. Families budget income and expenses. On the other hand, Governmental agencies budget revenues and expenditures. While businesses create budgets for planning and controlling their operations.

Budgeting is actually the strategic implementation of a business plan. It is a way of communicating agreed-upon goals within the business entity. Once adopted, it becomes an important tool for evaluating the performance of a business entity. 

Benefits of budgeting for business

A budget is an aid to management. While the benefits of budgeting can only be realized if managers correctly manage budgets. The major benefits of budgeting are as follows.

  • Budgeting requires all levels of management to plan ahead and define business objectives on a regular basis.
  • It provides specific objectives for each department so the evaluation of performance becomes easy
  • It makes it easier to coordinate activities within the business entity when different departments interact with each other and support the business goals.
  • It leads to increased managerial awareness of the entity’s overall operations as well as the impact of external factors such as economic trends on operations.
  • It helps in controlling activities. Managers can control financial activities by comparing actual spending to the budget.
  • It encourages employees throughout the organization to reach predetermined goals.

Essentials of effective budgeting

Effective budgeting depends on a sound organizational structure. It is because the sound organizational structure defines the authority and responsibility for all phases of operations. 

Budgets based on extensive research and analysis are more likely to produce realistic goals that will contribute to the growth and profitability of a business entity. Furthermore, the effectiveness of budgeting is closely related to its adoption by all levels of management.

Budgeting Process

The preparation of the budget for the coming year usually begins several months before the end of the current year. While some companies may take an entire fiscal year to complete it. The budgeting process generally starts with the collection of significant data from each department of the company. While formulating the future budget goals, past performance is often the starting point.

The budgeting process is often informal for small companies. While talking about the larger companies, a budget committee has the responsibility for coordinating the preparation of the budget. The committee generally includes the president, treasurer, chief accountant (controller), and management personnel from each of the major departments of the company, such as sales, production, and research. The budget committee acts as a review board where managers can justify their budget goals and demands. Disagreements are reviewed, modified if necessary, and reconciled. At the end, budget is finalized by the budget committee, approved, and distributed.

Types of budget

There are many types of budget documents, but all of these documents are combined into a master budget. The master budget is a collection of interrelated budgets that acts as a plan of action for a specified time.

The master budget contains two types of budgets: operating budgets and finance budgets. Operating budgets are the those budgets that support in the preparation of the budgeted income statement. These budgets establish specific goals for the company’s sales and production personnel. Financial budgets, on the other hand, are primarily concerned with the cash resources required to cover expected operations and planned capital expenditures. Financial budgets consist on the capital expenditure budget, cash budget, and the budgeted balance sheet.

Let’s illustrate with this infographic the sequence in which they are prepared. The organization initially develops the operating budgets, beginning with the sales budget. Then, it prepares the financial budgets.

types of budgets

Sales Budget

The sales budget is derived based on the sales forecast. It represents how management estimate sales revenue for the budget period. The sales budget is prepared first. All of other budgets depends on the sales budget. The sales budget is the product of  expected unit sales volume for each product and the anticipated unit selling price.

Production Budget

The production budget is all about the number of units of a product that must be produced in order to meet expected sales demand.

Direct Materials Budget

The direct materials budget is prepared to find out the actual quantity of direct materials to be purchased. The budgeted cost of direct materials to be acquired can be calculated when the company determines the quantity of units to be purchased. It achieves it by multiplying the number of direct materials required by the expected cost per unit.

Direct Labor Budget

The direct labor budget specifies the number of hours and the cost of direct labor necessary to meet production requirements. 

The manufacturing overhead budget

The manufacturing overhead budget represents the anticipated manufacturing overhead costs over the budget period.

Selling and Administrative Expense Budget 

This type of budget anticipates the selling and administrative expenses of the business entity for the budget period. It also classify expenses as either variable or fixed.

Budgeted Income Statement

It is the most important end-product of the operating budget. It shows the expected profitability of business operations for the budget period. It also provides the basis for evaluating company performance.

Cash Budget

The cash budget shows anticipated cash flows. Cash budget is one of the the most important financial budgets. The cash budget comprises of three sections: Cash receipts, cash disbursements, and financing together with beginning and ending cash balances.

Budgeted Balance Sheet

The budgeted balance sheet forecasts the financial situation at the end of the budget period. This budget is created using the previous year’s budgeted balance sheet and the current year’s budgets.

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