Budget | Budgeting Process

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on October 2, 2021

Budget – Definition

A budget is a detailed plan, which shows the financial consequences of an organization’s operating activities for a specific future period of time. A budget acts as a financial model that summarizes future operations and it is usually viewed as a core component of an organization’s planning and control system.

Budgeting Process

The procedures and activities that are undertaken to develop the budget are called the budgeting process.

Explanation

The budget is a formal quantitative expression of the goals of Management. The act of preparing a budget is called budgeting. And the use of a budget to assist management in the controlling process is called budgetary control. However; in the budgeting process, the three terms sometimes tend to be used interchangeably. Thus through the process of budgeting, management specifies the events that must take place to ensure that target profit and other objectives will be achieved. A budget is usually drawn up for an annual period. The first step in the preparation of a budget is to look at actual expenditure and revenues for the previous year.
With a good accounting system, expenditure for the prior year will be broken down and reported in considerable detail. Since many expenditures tend to vary with sales or volume of production, the estimate of these elements may be the most sensitive part of the entire budget. And a good manager will base his entire budget on the advise gets from his sales & marketing people. Also, a budget should contain enough information presented in an orderly manner so that its purpose is communicated to the user. Too much information or too little information clouds the accuracy of the budget.

Purposes of the Budgeting Process

The budgeting process can serve five primary purposes. It should be noted that not all purposes are served by all budgeting systems. For example, in some small businesses, planning and resource allocation may be the only intended purposes of the budgeting system.

1. Planning

The most obvious purpose of a budget is to qualify a plan of action. The budgeting process forces the individuals within a business to plan. For example, in formulating a quarterly budget for five-star hotel, the hotel manager, the reservations manager and the food and beverage manager must work together to plan the staffing and supplies needed to meet anticipated demand for the hotel’s services.

2. Facilitating Communication and Coordination

For a business to plan operations effectively there must be good communication and coordination between all managers. The budgeting process provides a formal mechanism to enable this to take place. For example, to plan pricing structures and the number of ticket sales, the sales manager for Virgin Blue or Qantas airlines must know the flight schedules developed by the airline’s route manager. The budgeting process pulls together the plans of each manager in an organization.

3. Allocating Resources

Generally, A firm’s resources are limited and budgets provide one way of allocating resources among competing uses. A large retailer, such as Coles Mayer, would use the budgeting process to consider the many alternative uses that could be made of its limited resources. For example, managers running the company’s supermarkets would be competing for resources against managers operating its department stores and specialty stores. The budgeting process provides a forum for evaluating uses of limited resources.

4. Controlling Profit and Operations

The budget can serve as a benchmark to allow comparison against actual financial results at all levels of a business. For example, within a sales department, actual sales against budgeted sales may be reported on a weekly basis to help sales staff exercise some control over total sales. Also, the budgeted costs of a customer service department may be compared with actual costs each month to point to areas where there needs to greater cost control. As part of the budgeting process, Standard cost are often developed for major production inputs (such as direct material used in production) or activities. These ideal costs benchmarks to help managers to control financial resources.

5. Evaluating Performance and Providing Incentives

Comparing actual results with budgeted results also helps managers evaluate the performance of individuals, departments, divisions or the entire company. Since budgets are used to evaluate performances, they can also be used to provide incentives for people to perform well. For example, hotel managers of the Australian hotel chain All Seasons Hotels participate in a profit-sharing scheme that provides them with incentives to meet or exceed their budgeted profit goals.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.

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