Home » Operations Management » Why Business Budget Planning Is So Important

Why Business Budget Planning Is So Important

October 4, 2023
Bill Kimball

In most cases, for a governmental entity, the budget represents the legal authority to spend money. Adoption of a budget in the public sector implies that a set of decisions has been made by the governing board and administrators that culminates in matching a government’s resources with the entity’s needs.

Unlike a mortgage or equipment loan with set monthly payments, these short term notes can be paid off quickly with large payments. The cash budget will look a lot like a budget you would do for your personal budget. It includes income and expenses, as well as any cash overages or deficiencies. If you borrow money to purchase equipment you may also have a financing section. In your personal budget, this would be things like mortgages and car loans. First, we use the budgeted unit sales off of the sales budget we created first! If a business does not develop a budget, it will face a host of problems.

There also may be instances where a company has a short term cash flow issue. This can occur when a huge production run may be needed prior to a big selling season. In a strict performance budgeting environment, budgeted expenditures are based on a standard cost of inputs multiplied by the number of units of an activity to be provided in that time period. The total budget for an organization is the sum of all the standard unit costs multiplied by the units expected to be provided. Although this strict approach may be useful for certain types of operations, many organizations require a more flexible performance approach. For example, expenditures may be based simply on the activities or levels of service to be provided and a comparison of budgeted and historical expenditure levels.

Direct Labor Budget

Often in the past, management has imposed a budget from the top without considering the opinions and feelings of the personnel affected. A number of reasons may underlie such resistance, including lack of understanding of the process, concern for status, and an expectation of increased pressure to perform. Employees may believe that the performance evaluation method is unfair or that the goals are unrealistic and unattainable. They may lack confidence in the way accounting figures are generated or may prefer a less formal communication and evaluation system. Often these fears are completely unfounded, but if employees believe these problems exist, it is difficult to accomplish the objectives of budgeting.

  • For example, if you anticipate a large expenditure one or two years down the road for computer upgrades or equipment maintenance, it’s a good idea to start budgeting in advance.
  • Spending down to zero from each paycheck or monthly earnings is often the goal.
  • This information will help our buyers to purchase raw materials, especially if it has a long lead time to receive, or if we like to receive it close to needing it (this might be called JIT or just-in-time inventory!).
  • The master budget contains multiple components, so let’s take a look at each one of them individually first, then we will start putting the pieces together.
  • It includes income and expenses, as well as any cash overages or deficiencies.
  • The budget is prepared by dividing all of a government’s operations into decision units at relatively low levels of the organization.
  • By using the same concept of taking your monthly earnings and budgeting them down to zero.

Some companies offer budgeting services for businesses that can be broken down by department so that all managers can see the overall costs and revenues. For those managers new to budgetary management, there are courses and training available online to learn basic and advanced accounting practices. Financial forecasting is the process of determining how a business or department will perform at a predetermined future time. Great managers use financial forecasting to determine where they should invest money and where they should expect additional costs. When funding has been secured, detailed project budgets should be developed.

Selling And Administrative Budget

If you earn $3,000 a month, you spend or save precisely that amount with a zero-based budgeting practice until you end up with zero. Traditional budgeting may not allow cost drivers within departments to be identified. Zero-based budgeting is a more granular process that aims to identify and justify expenditures. However, zero-based budgeting is also more involved, so the costs of the process itself must be weighed against the savings it may identify. Zero-based budgeting, primarily used in business, can be used by individuals and families, too. By using the same concept of taking your monthly earnings and budgeting them down to zero.

Thus, the budget is implicitly linked to financial accountability and relates directly to the financial reporting objectives established by the GASB. Because a new budget is developed each period, the time cost involved may not be worthwhile. Second, it may reward short-term perspectives in the company by allocating more resources to operations with the highest revenues. In turn, areas such as research and development, or those that have a long-term horizon, may get overlooked.

list the three key benefits companies get from preparing a budget.

Operating Budget Responsibilities and Guidelines The development of annual budgets is part of a continuing planning process. Beyond the requirements for federal and state programs, the budget preparation process and related responsibilities will largely be determined by the local school board and superintendent.

Preparing A Master Budget

The main advantage of site-based budgeting is that those who best understand the needs of a particular organization are empowered to make resource allocation decisions. This decentralization of budgetary authority may also increase local accountability. Another potential advantage of site-based budgeting is the increased level of participation of the public and staff in budget development. Many site-based budgeting systems create committees composed of staff and community members to determine budgetary allocations. These committees give members a voice from the inception of the budget process, rather than merely when the budget is presented for public review and approval. In an educational environment, budgeting is an invaluable tool for both planning and evaluation.

list the three key benefits companies get from preparing a budget.

We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.

Forecasting facilitates planning efforts by quantifying the future costs/benefits of strategic decisions. Thus, budgetary priorities may be evaluated on the basis of their long-term impacts. Consistent with the evaluation objective, government budgeting is becoming increasingly outcome-focused. Fiscal austerity, coupled with intense competition for governmental resources, has precipitated an effort to ensure more effective use of resources at all levels of government.

Financial Analysis

Often, departmental managers are responsible for managing portions of the company’s budget. New managers may not have training in how to effectively manage a departmental budget, so they must develop the necessary skills.

Because individuals may serve in a variety of roles in the budget development process, the division of duties may differ among districts. It is important, however, to clearly define the staff assignments and parameters if the budget development process is to operate efficiently. With the advent of site-based decisionmaking, individuals lacking previous budget experience need clear direction in order to provide effective input. The line-item budget approach has several advantages that account for its wide use. It is a familiar approach to those involved in the budget development process. This method budgets by organizational unit and object and is consistent with the lines of authority and responsibility in organizational units.

The focus on long-range planning is the major advantage of this approach, and advocates believe that organizations are more likely to reach their stated goals and objectives if this approach is used. This budget will affect the variable portions of the selling and administrative budgets and will also feed into the production budget. The production budget is needed to figure out direct materials, direct labor and manufacturing overhead budgets. Hupana Running Company doesn’t have any outstanding loans, so we don’t need to worry about that section, but just be aware that it might exist.

Decision units are then ranked by their importance in reaching organizational goals and objectives. Therefore, when the proposed budget is presented, it contains a series of budget decisions that are tied to the attainment of the entity’s goals and objectives. Over the past 30 years, governmental entities in the United States have used a variety of budget approaches and formats. For more information on budgetary approaches, The National Advisory Council on State and Local Budgeting provides additional guidelines. In addition, many governments use a variety of hybridized versions to address the specific needs of the organization. Each of the five basic approaches has relative advantages and limitations.

However, to overcome its limitations, the line-item budget can be augmented with supplemental program and performance information. Finally, the budget is evaluated for its effectiveness in attaining the organization’s stated goals and objectives. Evaluation typically involves an examination of how funds were expended, the outcomes that resulted from the expenditure of funds, and the degree to which these outcomes achieved the stated objectives.

Mid-size and large corporations tend to use accrual accounting while smaller companies tend to use cash accounting. It is important to understand how both work, however, as companies with whom you work may manage their budgets differently. The scope and diversity of operations in an organization make comprehensive financial planning essential for good decisionmaking. The practice also favors areas that achieve direct revenues or production, as their contributions are more easily justifiable than in departments such as client service and research and development.

Although this approach offers substantial advantages, critics have identified several shortcomings that may make it inappropriate for certain organizational environments. The most severe criticism is that it presents little useful information to decisionmakers on the functions and activities of organizational units. Since this budget presents proposed expenditure amounts only by category, the justifications for such expenditures are not explicit and are often unintuitive. In addition, it may invite micro-management by administrators and governing boards as they attempt to manage operations with little or no performance information.

Individual decision units are then aggregated into decision packages on the basis of program activities, program goals, organizational units, and so forth. Costs of goods or services are attached to each decision package on the basis of the level of production or service to be provided to produce defined outputs or outcomes.