Budgets - Overview
Budgeting
According to the Institute of Cost and Management Accountants, UK, a budget is...
“a financial and/or quantitative statement, prepared and approved prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective. It may include income, expenditure and the employment of capital.”
Budgeting is thus, an important tool for financial planning and control in the organisation.
Difference between budgeting and forecasting
Forecasting involves estimating future events and analysing their implications on the budget. Forecasting is an integral part of budgeting.
Budgeting on the other hand, involves preparing budgets and using them as the basis for control. A budget is like a financial plan.
Moreover, within the organisation, forecasting may be done for various purposes such as future business conditions, identifying future opportunities etc. These estimates are not included in the budgeting process.
Functions of budgeting
Budgeting performs the following important organisational functions: -
- Planning – A budget provides a plan of action or a set of guidelines. It sets deadlines for departmental objectives as well as standards for performance measurement. These standards or targets give a direction to the activities of the business. Budgeting allocates resources to various activities and influences the process of business strategy formulation. More.....
- Coordination – Budgeting facilitates coordination of the various activities performed by different departments such as purchasing, production and marketing in a manner that ensures maximisation of organisational profit.
- Control – The budgets of individual departments act as performance standards. At the end of the budgeting period, the actual departmental performance is compared to the targets set by the budget. Thus, deviations from these targets are identified to evaluate performance and suitable action is taken where necessary. Budgeting facilitates reliable and accurate measurement of performance besides aiding in cost control.
Benefits of budgeting
The process of budgeting provides the following benefits to the organisation: -
- Management is compelled to anticipate the obstacles likely to arise in the course of achieving budgeted targets and is thus well-prepared to meet them.
- Budgeting enables control of income and expenditure
- It acts as a tool for monitoring and periodic evaluation of managerial policies and decisions.
- It facilitates optimal allocation of resources for maximisation of profit.
- It facilitates coordination and decentralisation of tasks while still retaining control. It helps identify weaknesses and deficiencies during the process of achieving targets.
- It gives a sense of direction to organisational activities.
- It provides systematic and disciplined solutions to problems.
Limitations of budgeting
The following limitations of budgeting should be given consideration along with its benefits: -
- Budgeting helps estimate future events through forecasting. However, the future cannot be predicted with complete accuracy and therefore, budgeting is not precise.
- Successful implementation of the budget implies cooperation and coordination between all managers, which may not always happen.
- The budget is merely a tool, which provides guidelines to, but cannot take the place of, management. It gives detailed information on how to achieve targets for the benefit of management.
- Management should avoid the mistake of putting too many expectations on the budget, since they all may not always be fulfilled.
Zero Based Budgets - compared with traditional process