Budget is a plan describing activities to be carried out with financial allocation, over a period of time. It is a guide about how the funds / activities are to be managed.
Vision and mission of the organisation need to be translated into some practices for taking actions by user departments. Budgets facilitate putting financial numbers against various activities. Therefore, budgets limit the scope of activities within the allocated resources unless revised later on.
Once activities are analysed alongwith figures, organisation can visualise whether mission can be accomplished at the end of period if the resources are earned / spent as per initial plan / budget.
Planning requires ongoing review and suitable revisions. Budgets are also financial plans and require to be compared with actual results so that required amendments can be carried out.
Ingredients of Budget
- Putting the reasons for preparing the budget (i.e. why do we need a particular budget? what needs to be monitored by preparing the budget?);
- Whether budget is required for organisation as a whole OR a particular factory OR department OR working capital OR item of profit & loss account (like raw material OR turnover),etc.;
- Bigger budget must be supported by sub-budgets (e.g. Organisation turnover budget must be supported by departmental budgets like production and marketing departments’ budgets).
- Define the period for which budget is to be prepared (i.e. whether monthly OR quarterly OR yearly, etc.);
- Period can be of few hours (e.g. budget for an event / meeting / conference);
- Period can be long term (e.g. 10-year budget) → long term budgets are avoided since future is uncertain and business dynamics keep changing ongoing.
- Listing of activities to be carried out to achieve the purpose;
- e.g. expense budget would list out different expense heads OR fixed asset budget would list out various assets planned to be acquired / repaired, etc.
- Translating activities into financial numbers → how much is planned to be earned from and spent on various activities?
- Financial numbers are not guess work or gut-feeling → these are based upon a certain logical assumptions OR quotations from vendors OR market survey reports, etc.
- To avoid unreasonable over-allocation on an activity → can result in availability of less resource for other activities.
- Calculating and analysing variances of budgets vis-à-vis actual;
- Modification of budgets, if required;
- Incorporating the changes in future budgets.
Advantages of Budgets
- Better allocation of resources than random allocation
- Resources and time are limited for any organisation → need to be used judiciously for maximum results ;
- Once resources are allocated for an activity through budgeting → puts restriction for utilisation for any other purpose.
- Conveys mission of the organisation
- Commitments of the organisation are conveyed through budgets;
- E.g. Organisation may have mission for delivering CSR (corporate social responsibility) but its budget must reflect spending on CSR.
- Drives people to the Vision
- Budgets communicate what would be visible at the end of budget period;
- Expectations of user departments and its people are integrated → everybody knows what needs to be done activity-wise.
- Budget is an organised document for funding agencies / investors
- Investors know how their funds are going to be utilised by the organisation → helps them in taking investing decisions;
- Leaves a better impact that the organisation is organised and well-prepared for future activities.
- Forecasting tool
- Forecasting techniques use the statistical tools to predict the future using historical data;
- Budgets also use past information coupled with anticipation of future based upon some concrete plans / strategies → better forecasting tool.
Disadvantages of Budgets
- Budgeting is planning exercise → unless conducted in an organised manner → would yield poor results;
- Budget vs. Crisis situations
- Crisis (i.e. emergencies like accidents due to fire, floods, attacks, etc.) demands immediate actions;
- Budgets need to be bypassed to handle crisis.
- Time investment in budgeting
- Budget preparation must not be a lengthy exercise where senior management is busy in series of meetings;
- Budgeting makes the person away from core responsibilities → requires proper management.
- Zero budgeting begins with allocation of zero resources for an activity;
- Activity owner (i.e. person proposing an activity to be conducted) needs to justify why the resources need to be spent on that activity;
- Allocation of resources only after discussion with other participants of budgeting;
- Facilitates review of all activities at each budgeting.
Steps in Budgeting
- Deciding what needs to be budgeted;
- Determining the period for which budget is to be prepared;
- Budget to be prepared by each department.
- Identifying various activities for a budget;
- Allocating the resources for various activities alongwith the basis (or assumptions) of allocation;
- Predicting revenue / funds inflow for income or receipt activities alongwith its basis of calculations;
- Consolidation of all budgets to get first draft of overall budgets;
- Discussion amongst all departments using zero budgeting tool;
- Ensuring that the budget is in alignment with organisation’s vision / mission / goals;
- Finalising the allocations over various activities;
- Circulating the final budgets.
- Periodical comparison of actual vis-à-vis budgets → identifying variance;
- Analysing variance
- Mistakes due to planning to be built in future budget;
- Surplus resources to be released for other activities;
- Arrange resources OR prune budgets for deficit budget activities.
- Sharing the results
- Making the budgeting more involving exercise;
- Share the success and failures of planning.