Budgets and Budgeting
A budget is a document that translates a group’s or organization’s strategic and operational plans into the expected resources required and anticipated returns over a certain period.
Types of budgets
- Operating budgets reflect a group’s or organization’s day-to-day revenues and expenses. They typically cover a one-year period.
- Capital budgets show planned outlays for investments in plant, equipment, and product development. Capital budgets may cover periods of three to 10 years.
- Cash budgets plot the expected cash balances an organization will experience during the forecast period, based on information provided in operating and capital budgets.
A budget functions as financial blueprint or action plan that a group or organization uses to ensure that it has enough resources to achieve its goals. The budget also helps ensure that achieving those goals generates the desired benefits.
Budgets are essential to companies or organizations as they help:
- Put all of its financial components into one coherent picture that shows its strategic and operational goals along with its financial health
- Align individual teams, departments, and business units behind the organization’s goals
- Allocate resources wisely
- Communicate financial expectations
- Evaluate and motivate managers’ and employees’ performance
- Communicate goals to external stakeholders
- Take corrective action when actual business results don’t match the target results shown in the budget
Budgeting or the budget development process begins by establishing assumptions for the upcoming budget period. These assumptions are related to projected sales trends, cost trends and the overall economic outlook of the market or industry of the company or organization.
The different divisions or groups of a company or organization prepare preliminary budgets. They then come together to identify and resolve differences. Coordination and communication between people at different levels of the organization and across functions are critical for arriving at useful budgets.
Types of Costs
In building your budgets, you need to distinguish between several types of costs: fixed, variable, and corporate overhead.
Fixed costs remain fairly constant within a wide range of production or sales volumes during the budget period. Examples include:
- Basic utilities, including electric and telephone service
- Equipment leases
- Interest payments
- Administrative costs
- Marketing and advertising
- Indirect labor, such as salaried supervisory employees
Variable costs change in direct proportion to changes in activity during the budget period. Examples include:
- Raw materials
- Direct labor
- Energy (electricity, gas) used in manufacturing or production
- Sales commissions
- Income taxes
Your estimates of variable costs that will be incurred during the budget period will depend on your group’s or organization’s plans. By understanding those plans, you can anticipate the need for resources (such as expanded capacity) and include them in your budget requests.
Operating budgets may include corporate overhead costs. These costs are associated with operating the company but may not be tied to individual products or departments. These costs typically include office rent for the building occupied by corporate headquarters, as well as salaries and expenses associated with corporate management.
How these costs are attributed to individual departments varies from one company to another. Some organizations may allocate overhead only to certain departmental budgets—such as those that generate revenue.