Budgeting is specific financial planning into the future for the whole business organization, agreeing to the plans, and then following them through the year to fulfill as closely as possible.
- Firstly, a budget is a method of planning, monitoring and controlling business activity.
- Secondly, a budget is a quantitative expression of that financial planning prepared in advance of the period to which it relates to.
- Thirdly, a budget is a table setting out projected figures for specific areas of business activity such as sales and costs.
Budgeting is not forecasting. Although much of the financial data used for budgeting comes from various types of forecasts, forecasting means making generalized predictions of what could happen in the future under certain conditions.
Important features of budgeting to consider
Bearing in mind the importance of budgeting and purposes of setting budgets, there are several key considerations for business managers when budgeting.
1. Budgeting is prepared in advance
Budgets are prepared and agreed in advance. Being forward-looking financial plans, budgets cover a specific time period in the future, usually one year. Sometimes budgets are broken down into quarters and months.
While the specific purpose of budgeting will depend on the type of business organization, budgets serve to help managers to plan, monitor and control business activities. Budgeting helps to ensure that managers plan ahead anticipated costs and revenues of different business activities. Generally, budgeting is assisting in decision making as it helps to see the outcome of certain actions.
As business budgets are based on the objectives of the business, specific organizational objectives must be considered in the planning stage.
For example, if a business is planning to expand internally, then, budgets need to be raised accordingly as both the number of new products produced and the number of production and sales workers will need to be significantly higher.
2. Budgeting requires cooperation
Cooperation between different business departments when establishing budgets is necessary to avoid making conflicting plans across different business functions.
Cooperation requires participation. This will most likely lead to negotiations as budgets are often set through discussions between Functional Directors are budget holders. The Budget Holder is an individual responsible for the initial setting and achieving of the budget. The stronger the business is financially, the greater the budgeted expenditure can be allocated to each budget holder in a firm.
Coordination must be conducted with a full system of budgetary controls. So, managers of different functions within the firm (i.e. Marketing, Human Resources (HR), Finance and Operations/Production) will be able to make decisions about the future which are not in conflict with other departments.
In addition, the firm needs to ensure appropriate communication within and between departments.
For example, if the marketing department is planning a new advertising campaign to boost sales of new products in new markets, the production department should not plan to reduce the output produced, but be prepared to produce larger volume of products.
3. Budgeting is measurable
Budgets are expressed in either real terms (physical quantities) or financial terms (measurable values). Budgeting can really be done for any part of a business organization as long as the outcomes can be measured in numbers.
Information contained in a budget may include any or a combination of the following quantitative Budget Factors: Sales Volume, Sales Revenue, Expenses, Profit, Personnel, Cash, Capital, etc. In fact, a budget can also really include any business variable which can be given a monetary value.
For this purpose, Cost Centers and Profit Centers are often established. They will have budgets set including budgets for sales, capital expenditure, labour costs, profit and so on.
For example, the budget will be set for launching the new advertising campaign to increase sales of new products into new markets. Spending on advertising in relation to this particular promotional campaign can be clearly measured in numbers.
4. Budgeting can be delegated
Delegating budgets mean giving away some authority over the setting and achievement of budgets to junior managers. By delegating the budgetary control down the chain of command (from the senior management to the junior management and lower-level workers) all individuals in the business are given the opportunity to set and measure their own performance.
This sense of ‘ownership’ (constructing the budget, taking responsibility for its operation and being appraised in terms of success) leading to self-realization, will lead to having more realistic targets across the firm.
For example, after seeing the budget for launching the new advertising campaign, the sales specialists decided on how much revenue each of them will be able to generate for the firm.
5. Budgeting motivates
Budgets play an important role in motivating staff as they make individuals responsible for their performance. According to the Herzberg’s motivation theory, responsibility and employee participation motivates people.
Firstly, involving people throughout the organisation in the process of budgeting will help to bring all the workforce closer together. Secondly, setting challenging yet achievable targets will help to satisfy some of the Maslow’s higher-order needs. And thirdly, delegated budgets make daily work more challenging and rewarding. It is because, those who are to be held responsible for fulfilling a budget are also involved in setting their own quantifiable targets.
Motivation will help to boost productivity, reduce absenteeism and reduce labour turnover.
For example, some of the sales people may work really hard towards the end of the budgeting period, if they see that there are only a few percentage points for them to achieve in order to meet their targets and receive performance-related pay.
6. Budgeting helps review performance
As we know, budgets not only help to improve financial control, but also has the feature of enhancing performance.
Budgets help to evaluate performance of the business, its smaller parts and individual employees. As time passes by, business managers compare actual figures with budgeted numbers.
Budgets provide data for rewarding each individual employee. Therefore, it will be used to review the performance of the managers controlling different products, regions and divisions which are considered as Cost Centers and Profit Centers in the budget. The managers responsible for each will be appraised based on their effectiveness in reaching targets. Hence, budgeting will make it possible to identify successful and unsuccessful managers.
Also, thanks to budgeting, the firm will be able to benchmark the business and its different sections against the performance of its nearest competitors.
For example, let’s say that the budget of USD$1,000,000 set for the new advertising campaign generates USD$2,000,000 of sales revenue. After finding this out, other rivals will benchmark against these numbers reviewing their own performance comparing advertising spending with sales revenue generated.
In summary, business budgets are specific financial plans that organizations aim to follow through the year and fulfil. Planning for the future must also consider the financial needs of a business and likely consequences of these financial plans.
