1Business

Budgets & Budgeting

Budgets and Budgeting

A budget translates a group’s or organization’s strategic and operational plans into the expected resources required and anticipated returns over a certain period. It is an estimation of revenue and expenses over a specified future period of time.

Types of Budgets

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Financial Blueprint

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.

Typically, formulating a budget is an iterative process: Different groups 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.

In an organization in which upper management defines strategic and operational goals, senior managers must communicate those goals to managers at all levels. Functional-area managers, business unit heads, and team leaders need to communicate their particular needs, assumptions, expectations, and goals to those who evaluate the departmental and functional budgets.

In addition, the different groups within the organization must listen to one another. For instance, if one division wants to achieve certain sales goals, then the production department needs to know that, so it can prepare to increase production capacity. If the company wants to introduce a new service, then the marketing department has to know about this early in its planning process. That way, marketing can include funds in its budget for developing effective advertising campaigns for the new offering.

Traditional and alternative approaches

There are many different approaches to the budgeting process. Some of them are traditional; others are designed for changing business needs  and newer ways of working. 

Traditional budgets are generally easier to build, and they simplify the coordination of assumptions across departments. On the downside, their timing is frequently off: The periods they cover are either too long or too short to reflect real conditions. Moreover, traditional budgets can be simplistic or overly complicated, or inflexible or political.

Alternative budgets, such as zero-based budgets, try to deliver greater accuracy and functionality. But creating them and embedding them into company practice is a major undertaking. It can distract managers' attention from their critical activities.

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Types of Costs