A budget is a detailed plan of operations for some specific future period. It is an estimate of costs and benefits of programs to be undertaken and policies thereto prepared in advance of the period to which it is applied. Budget acts as a business barometer as it is a complete program of activities of the business for the period covered.
According to Gordon and Shilling law, ‘budget is a predetermined detailed plan of action developed and distributed as a guide to current operations and as a partial basis for the subsequent evaluation of performance’.
According to Weygandt, Kimmel & Kieso, “A budget is a formal written statement of management’s plan for a specified future time period, expressed in financial terms. It represents the primary method of communicating agreed-upon objectives throughout the organization. Once adopted, a budget becomes an important basis for evaluating performance. It promotes efficiency and serves as a deterrent to waste and inefficiency”.
The Institute of Cost and Management Accountants, England, defines a budget as ‘a financial and/or quantitative statement, prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective’.
Thus, the following are the essentials of a budget:
- It is prepared in advance and it is a plan of actions for the feature.
- It is related to a future period and is based on objectives to be attained.
- It is a statement expressed in monetary and/or physical units prepared for the implementation of policy formulated by the management.
Different types of budgets are prepared by concerns for different purposes. A sales budget is prepared for the purpose of forecasting sales for a future period and on its basis other budgets are prepared. An operating cost budget is prepared for forecasting the operating costs. The order in which the four budgets would be prepared is as follows:
- Sales budget– Sales Budget is one of the important functional budgets. Sales estimate is the commencement of budgeting may be made in quantitative terms. Sales budget is primarily concerned with forecasting of what products will be sold in what quantities and at what prices during the budget period. Sales budget is prepared by the sales executives taking into account number of relevant and influencing factors
- Finished stock budget– After preparing sales budget, production budget, direct materials budget, direct labour budget, and manufacturing overhead budget the management has all the data needed to calculate unit product cost. This calculation is needed for two reasons: first, to determine cost of goods sold on the budgeted income statement; and second, to know what amount to put on the balance sheet inventory account for unsold units. The carrying cost of unsold units is calculated on the ending inventory finished goods budget.
- Production budget– Production budget is usually prepared on the basis of sales budget. But it also takes into account the stock levels desired to be maintained. The estimated output of business firm during a budget period will be forecast in production budget. The production budget determines the level of activity of the produce business and facilities planning of production so as to maximum efficiency. The production budget is prepared by the chief executives of the production department. While preparing the production budget, the factors like estimated sales, availability of raw materials, plant capacity, availability of labour, budgeted stock requirements etc are carefully considered.
- Materials usage budget- Direct materials budget or materials budgeting details the materials that must be purchased to fulfil the production requirements and to provide for adequate inventories.
The Master Budget embodies plans – for the revenues and gains and other incomes, for operating, marketing and other expenses, for cash and capital requirements besides forecasting the profit or loss.
Why Budget is Important for Business?
Some employees will question the need for a budget. The procedure of budget preparation is at times seen as difficult, and it is not constantly clear how the attempt that is required leads to any fruitful production. Furthermore, budgets can be seen as imposing constraint that is hard to live with and establish goals that are difficult to meet.
Despite these dismal remarks, it is very important that organizations carefully plan their financial affairs to attain financial achievement. These plans are normally expressed as “budgets.” A budget is detailed financial plans that quantify future expectations and actions relative to acquiring and using resources.
In small organization, formal budgets are an unusual object. The individual management/owners likely manage only by reference to a common mental budget. The person has a good sense of estimated sales, costs, financing, and asset needs. Each operation is under direct oversight of this person and confidently she or he has the capacity to keep things on a logical course. When things don’t go well, the management/owners can normally take up the slack by not taking a pay check or engage in some other form of financial requirement. Of course, much small business eventually is unsuccessful anyway. Explanation for unsuccessful are several and varied, but are often pinned on “undercapitalization” or “insufficient resources to sustain operations.” Many of these post-mortem assessments reflect a failure to adequately plan! Even in a small company, a reliable business budget/plan can often result in anticipate and avoiding terrible outcomes.
Medium and big organization consistently relies on budgets. This is likewise true in business, government, and non-profit organization. The budget provides a formal quantitative phrase of opportunity. It is an essential aspect of the planning and control process. Without a budget, an business will be highly unproductive and ineffective.
There are several advantages of detailed budgeting for business which are;
- First of all creating a budget is a long term perspective so it enables to think in a long term and moves away from making short term goals. It also allows thinking long term financial position and profitability of a business no matter if the planned budget doesn’t successes.
- Making a detailed business budget allows to pin point where the company generates it most of the revenue as in many cases it is easy that the management looses the most profitable aspect. It forces management to consider to whether it should let go non productive part of business and which new one to invest in.
- Budgeting allows business to think what the key purpose of the business is and to forecast environmental factors that may affect the performance of the business. This forecasting enables to develop strategy to overcome different environmental pressure.
- A detailed budgeting allows business to look forward what future cash flows will be required for the expansion of the business and from where to generate funds in order to meet the future growth needs.
- Formulating a budget also allows you to evaluate the performance of the business. Where the business is now and where to be and how to get there. It provides step by step information which is helpful in reaching where the business wants to be. Without budget it is very difficult to evaluate the current performance of business. It measures the planned performance with actual which gives a complete and true picture of the business.
- Budgeting enables managers to decide where to allocate funds as cash are always limited. Whether to invest in fixed assets to increase production for matching future demands or to invest in working capital. It also enables business to decide which asset is worth investing.
- A realistic established budget enhances the probability that the business will successes because it contains all the essentials and targets that have to be accomplished and also enables the business owner to according to the planned activities.
- In addition detailed budgeting also helps to formulate different department goals and different functional goals. The functionality of all the departments are necessary to run the business mechanism. Basically budget creates a harmony among the entire department prevailing in a particular business.
- A budget is not only useful for owner or managers of business but it is also useful for the investors. Budgets helps investors to check if the business have enough potential and if the business if worth investing. Investors see the budget to find out what are the goals of business and investing in that particular business will maximize the probability of better return in terms of interest.
- Budgets are not just useful in comparing your own performance with the planned one but it is also useful in comparing the performance of your business with the overall industry, like what are the labor rate prevailing in the market, what price to charge from customer, what volume to sell in order to get maximum revenue.