A budget is a plan expressed in monetary terms and prepared for a specific period of time. It usually shows expected income to be generated and expenditure to be incurred during the period, and the capital to be employed to achieve a given target. Generally, budgets are developed within the context of an ongoing business and based on previous decisions that have been made within the long-term planning process.
organisation will produce a sales budget and from that production and inventory
budgets, culminating in a series of expenditure budgets
(direct materials, direct labour, factory overheads, selling and administration expenses etc.).
These budgets are known as functional budgets.
Once all of the various
budgets have been prepared, reviewed, revised and agreed a budgeted profit
and loss account
and balance sheet
are prepared and this is
called the Master budget.
A cash budget shows the cash inflows and outflows for an organisation for a specific period of time. It is usually prepared on a monthly basis but may be prepared quarterly or weekly or as required. The cash budget highlights any cash shortfalls or surpluses expected to occur within a given period allowing the organisation to plan the measures necessary to deal with these situations.
The benefits that may arise from budgeting include:
- Planning: budgeting facilitates planning for future operations as managers become aware of the long range objectives of the company. It also encourages managers to anticipate potential problems that may occur and plan their resolution.
- Co-ordination: there is better co-ordination of the various functions of the business as managers examine the operations of their departments relative to other departments.
- Communication: the budgeting process requires that all levels of the organisation are informed of long range plans, providing and receiving feedback throughout the budgeting process.
- Motivation: a budget, if it is realistic and prepared with the participation of managers, provides a standard of performance that managers will strive to achieve. However, if a budget is set by higher level managers and imposed on lower level managers it may be resisted and cause dissatisfaction and demotivation.
- Control: a budget assists managers in controlling the activities for which they are responsible by allowing them to compare actual performance with expected or budgeted performance. Any significant differences may then be investigated and inefficiencies highlighted for remedial action.
- Performance evaluation: a manager’s performance may be evaluated by reference to how well budgeted results are achieved. Budgets thus allow managers to gauge how well they are meeting targets that they have been involved in setting.