We have heard or engage on daily to daily basis on preparing a plan for daily or monthly or annual expense. So, In Simple words, the creation of plan how to spend money is called Budgeting.
In a more sophisticated Way, Budgeting is a Financial plan used to organize Company Resources and its Man- power so that they can achieve their goals. The act of Preparing a Budget is called Budgeting. It is re-evaluated on a periodic basis. Budgeting is good when you plan to spend less money than your earnings.
Purpose of Budgeting
- It helps in identifying where we can cut unnecessary expenses.
- It increases financial planning and decision making
- It helps in translating financial objectives into projected monthly spending pattern.
- It helps in providing feedback for budget utilization.
Principals of Budgeting
- The Activities and the projected expenses for a time (annual or monthly) is planned in advance.
- It confirms the most effective use of resources (financial or non-financial).
- It helps in performance review of the previous year in terms of both quality and quantity.
- Budgeting focusses on the Goal, Plan & Strategy of the Organization
- Budgeting must be prepared under the management and direction of Chief Financial Officer or Controller etc.
- Budgeting provide checks or scan on adopting too high or too low estimates.
- Budgeting helps in providing flexibility on your Expenses. For Eg: It gives an overview that which sector we can cut expenses and which sector should we can increase expenses according to the needs.
- Budgeting establishes a frame of reference for evaluating managerial decision and their performance.
- It should be prepared and is explained throughout the organization.
Types of Budgeting
Here we will discuss the types of budget
Master Budget: Master Budget is the combination of all other budgets (Like Sales Budget + Production Budget + Capital Asset Acquisition Budget + Cash Budget + Income Statement + Balance Sheet) prepared for a specific period.
It shows the overall budget plan. Master Budget is made once a year. Master Budgets acts as a Summary Budget for the Management or Business Owners to indicate the Organization earning and Expenses.
- Operating Budget: Operating Budgets are made to analyze the funds require in successful running of the business. It can be said as a Revenue and Expense Budget because It represents the company’s expenses, expected costs and estimated income to use for its operation.
Types of Operating Budgets are Sales Budget, Selling & Distribution Budget, Production Budget, Production Cost Budget, Materials Budget, Purchase Budget. Operating budget helps in setting up financial responsibility, reduces business debt , helps in managing current expenses and helps in projecting future expenses.
Capital Expenditure Budget: Capital Expenditure is also called CapEx or Capital Expenses. Capital Expenditure is that Capital/Money/Finance which is used to buy, improve or increase the life of fixed asset or long term assets (especially more than one year) in an organization.
These Assets include Equipment, Property and Infrastructure. There are two types of Capital Expenditure: Maintenance Expenditure and Expansion Expenditure. Capital Expenditure is done for Long Term Effects.
Cash Budget: Cash Budget is the detailed Estimate of the Expected Cash Inflow (Cash Receipt from all sources) and the Expected Cash Outflow (Cash Payment for all purposes) results the Cash Balance during the Budget period.
Cash Budget includes details of transaction where the money comes in or go out. It does not includes credit sales or depreciation where the money is not received or cash goes out.
The Methods used in Preparing Cash Budget are as follows: a) Receipt and Payment Method b) Adjusted Profit and Loss Method c) Balance Sheet Method
Direct Labor or Personnel Budget: What is Direct Labor? Any Labor who is directly linked in the production process is called Direct Labor. All Manufacturing companies are required to make the direct labor budget.
The Direct Labor Budget shows the cost and hours required for production. The Budget is prepared on monthly or quarterly basis.
Direct Labor can be measured by
Production estimates (units) * Direct Labor hour per unit * Direct Labor cost per hour = Total Direct Labor cost
For eg A Factory needs to produce 5000 units , now a labor takes 3 hours to produce 1 unit , so it will take 15000 hours to produce 5000 units. Now suppose a Labor charges Rs. 50 per hour , then the total direct labor cost would be Rs. 50 *15000 = Rs 750000 = Total Direct Labor cost.
Flexible Budget: As the name Suggest, Flexible Budget is a Budget which can be changed according to the circumstance and is also called Variable Budget. Here the Adjustment can be made according to the situation.
Here the Budget can be changed if the Level of activities varies. The costs are classified according to the nature i.e. fixed, variable or semi-variable.
The impact of expenses on operation is clearly shown on Flexible budget which helps in making accurate forecast.
The Flexible Budget can be redrafted as per change so comparison between Budgeted and Actual figures will be possible.
Strategic Planning Budgeting : Strategic Budgeting is the process for creating Long range budgets (more than one year ). Such types of Budgeting is done for developing a plan for supporting long term vision.
Strategic Budget is barely concerned with the detailed revenue and expense.
Classification of Budgeting
- Incremental: Incremental Budgeting changes an Existing Budget. It is a process in which the existing budget is either added or subtracted few things to make a new budget.
Incremental Budgeting = Current or Existing Budget [(plus) or (minus)] few things.
This is a simple methods and Management prepare such kind of budgeting if they do not have enough time for preparing budget.
This type of Budgeting requires Past Year Evaluation and from there It either increase or decrease and accumulate for the upcoming year.
Rollover Budget: Rollover budget is also called Continuous Budget or Rolling Budget or Perpetual Budget. It allows the amount to be carried forward from one budget period to other period.
Rollover Budget is always prepared on the basis of Past Values and Forecasted Demand. We combine (Past Values + Forecasted Demand) them and then prepared the Rollover Budget. It may be prepared Quarterly or Half-Yearly or Annually.
Zero Based Budgeting: Zero based Budgeting is given by Peter Pyher in 1969. Generally we take Past data to make budgets, but here No Past data is taken.
Each time We have to start with Zero to make Budget, thus called Zero based Budget. Zero Based Budgeting activities are selected in the order of priority of their importance.
This type of budgeting is used for reduction in repetitive activities.
Performance Budgeting: As the name Suggest, Such type of Budgeting is based on Performance in which it reflects both the input of resources and output of services for each unit of an organization.
This types of budget is basically used by Government (Central or State) Agencies. For e.g. Government takes taxes from the Taxpayer and it gives in return by making infrastructure for the people.
Such types of Budgeting is used for Long Term Planning, Cost-Benefit Analysis, Allocation of resources etc.
Sales Budget: Sales Budget is also called Revenue Budget and is the first and basic component of Master Budget. It shows the expected number of sales units of a period and the expected price per unit and also shows total sales.
Sales Department makes different ways of Sales Budget according to their requirements. Sales Budget can be Product Wise, Territory Wise, Period Wise, Event Wise, Customer Wise, Salesmen Wise.
Program Budget: Program Budget is a Budget which is prepare specifically for a Program or Project. The Expenses and Revenues are related to the specific program only.
It helps in examining the areas where higher funds are required.
Production Budget: The Production Budget is prepared for prediction/estimation of the Production for the budget period. It is based on Sales Budget.
Production budget is based on Product Wise, Period Wise and Plant Wise.
Advantages of Budgeting
- In Budgeting, All the activities are planned in advance which leads to maximum utilization of resources thus ensures maximum return in the organization.
- Budgeting improves the awareness of employee about the business enterprise at all levels of management which helps in achieving organizational targets.
- Budgeting helps in better coordination among different function/department/activities thus helps in better understanding among them.
- Budgeting is prepared by the top management thus shows the active participation and ensures support from them in achieving target and objectives.
- Budgeting helps in Self Evaluation about the actual and target performance.
- Budgeting helps to fix goals in advance and thus acts as a motivating force in achieving target.
- Budgeting ensures the effective utilization of resources and thus creates a cost consciousness throughout the organization.
- Budgeting creates the performance measurement of different departments and different functions of organization.
Disadvantages of Budgeting
- Budgeting is a time taken process as the implementation of budgeting system is a lengthy and time consuming activity.
- One department can blame the other department of not supporting if the targeted goal is not achieved. So, Blame Game Starts.
- Budgeting is Costly. It requires experienced man-power, technical staff, data analysis, control tools etc.
- Every Budgeting System requires an effective control system. Most organization do not have effective control system , thus results in failing the budget process.
- The Success of Budgeting depends upon the full support of Top Management. Most of the cases, the Top Management does not provide the support thus fails in budgeting process.
Budgeting is very Important as it helps in planning your expense, actual expense, your target goals and achieved goals. We all do Budgeting in many sense like Individuals do Budgeting for monthly household expenses, The companies do Budgeting for their target goals and achieved goals and Government do Budgeting to distribute equal proportion of resources to each sector and save for emergency.