A budget is a document that translates plans into money – money that will need to be spent to make your planned activities done (expenditure) and resources that will need to be generated to cover the costs of getting the work done (income).
The budget of a business firm is normally compiled annually, but may not be. A finished budget, usually requiring considerable effort, is a way for the short-term future, typically one year (see Budget Year). While traditionally the Finance department compiles the firm’s budget, advanced software allows hundreds or even thousands of people in different departments (operations, human resources, IT, etc.) to submit their expected revenues and expenses in the final budget.
If the actual figures delivered through the budget period get close to the budget, this suggests that the managers understand their business and have been successfully driving it in the intended direction. On the other hand, if the figures diverge wildly from the budget, this sends an ‘out of control’ signal, and the share price could decline as a result.
The key to successful budgeting is both cause and inflexibility. Certain expenses are fixed, so payment of those bills should be a conservative element. Nothing is more powerful than paying those particular bills in full. In business, departments need to know the whole ceiling on spending. Budgeting works best when exceedingly rare exceptions are made to the upper limits. The concept of financial responsibility is to create a workable budget and stick to it as best as possible.
A contingency amount is an amount that can be set aside to deal with unplanned events. While budgets should be informed guesses, there is still a part of “guessing” in them. The future is uncertain and organizations and projects have to stay in uncertain times. Because of this, some organizations allow for a “contingency” line item in their budgets – usually about 10% of the overall annual budget.
However, many donor agencies do not like this and refuse to support a “contingency” line item, perhaps because they believe that organizations and projects should be more accurate in their budgeting. One way to deal with this is to develop contingency amounts into the significant line items in your budget, allowing for an additional 10% over and above your calculations.
This is the minimum required in order for the plan or project to exist and make productive work.
The Guaranteed budget:
This is based on the income guaranteed at the time the budget is planned. Usually the “guarantees” are in the form of promises from donors. However, unexpected situations, such as a donor contribution coming through devilishly late, may make it necessary to switch to your survival budget.
This covers what would be liked to do if it can be gotten more funds. Once more money comes in or is promised, it becomes part of your working budget.
The Incremental budget:
Which figures are based on those of the actual expenditure for the previous year, with a percentage added for an inflationary increase for the New Year. This is a natural system that saves time but it is the “lazy” system and is often mistaken. This budgeting method is only suitable for organizations where each year is remarkably similar to the previous one in terms of activities. Very few powerful organizations or projects are so reliable that this budgeting system actually works for them.
Advantages of incremental budgeting:
The budget is established and change is gradual.
Managers can manage their departments on a consistent basis.
The process is relatively straightforward to operate and easy to understand.
Conflicts are avoided when departments seem to be treated similarly.
Co-ordination between budgets is easier to obtain.
The impact of change can be seen immediately.
Disadvantages of incremental budgeting:
Assumes activities and methods of operation will remain in the same way.
No basis for developing new ideas.
No incentive to reduce costs.
Encourages spending up to the budget so that the budget is maintained next year.
The budget may become out-of-date and no longer apply to the level of activity or type of work being carried out.
The priority for resources may have changed since the budgets were originally set.
There may be budgetary surplus built into the budget, which is never reviewed. Managers might have overestimated their requirements in the past in order to obtain a budget which is easier to work within, and which will allow them to achieve favorable results.
Past figures are not used as the starting point. The budgeting process starts from “scratch” with the proposed activities for the year. The result is a more accurate and realistic budget, but it takes more time and energy to prepare a budget in this way. This method is ideal for different organizations and projects, but it is also probably the best way to go in a dynamic organization that is proactive in taking on new challenges.
Advantages of zero-based budgeting:
Efficient allocation of resources, as it is based on needs and benefits.
Drives managers to find cost effective ways to improve operations.
Detects inflated budgets.
Useful for use departments where the output is difficult to determine.
Increases workforce initiative by providing greater creativity and leadership in decision-making.
Increases communication and coordination within the organization.
Identifies and eliminates wasteful and discontinued operations.
Identifies opportunities for outsourcing.
Forces cost centers to identify their mission and their relationship to overall goals.
Disadvantages of zero-based budgeting:
Difficult to determine purpose units and option packages, as it is time-consuming and thorough.
Forced to explain every aspect related to expenses. The R&D department is threatened whereas the building department benefits.
Necessary to prepare managers. Zero-based budgeting must be clearly understood by managers at various levels to be successfully implemented. Difficult to administer and communicate the budgeting because more managers are involved in the process.
In a large organization, the number of forms may be so large that no one person could see it all. Compressing the data down to a serviceable area might go critically pertinent details.
Honesty of the managers must be established and reliable. Any principal that exaggerates skews the results.
When economic times are correct, many people become careless about personal budgeting. As long as there is, more money coming in than going out, all is well. Nevertheless, those who learn to create a workable budget and stay within it during the hard times often remain chief financial crises better than those who do not.
Budgeting requires solid working models of cost performance, financial condition, and cash flow from profit. Constructing sizeable budgets is a strong incentive for businesses to develop financial models that not only help in the budgeting system but also help managers in making strategic decisions.
There is a collection of benefits that anyone can benefit from budgeting too. Large financial institutions and governments use budgeting in order to support the amount of capital they are spending around their organizations. This is essentially one of the primary benefits that an individual can receive from budgeting as well.
The first step to any budgeting process is the process of discovering where all of the capital owned by an individual is going. Once it can be known where most of your funds are going, it will be in a much better position to start allocating specific amounts to each part of the life.
This is where the main benefits of budgeting enter the picture too. Once defined procedure is set for the budgeting, it will be able to limit the amount of capital that is going into each of your daily activities.
Along with knowing where it might be spending are going, it will also be acutely aware of how the money is spent. This type of consciousness or places a rather strong constraint on the amount of money it can be spent. Once it is stopped spending frivolously, it will be in a much better position financially.
The advantages of budgeting are truly impressive. There are also many advantages to be had by anyone who wishes to retain a budget. If it is used a budget in your own life, it can be expected to start saving money nearly complete. It will also quickly notice that it has been more money in the bank account once it is started using a budget in the finances.