Budgets

Setting the budget for a business involves planning the income and expenditure for the accounting year. This is usually broken down into months so that planned budget and actual figures can be compared.

How it works

Every business needs to budget for anticipated revenue and operating costs within the financial year. Unlike capital budgeting, in which senior management allocates what will be spent on specific projects or assets, revenue budgeting focuses on the overall projections for money coming in and money going out for each month of the coming financial, or accounting, year. Accountants compile operating budgets from each manager in the business, along with expected cash-flow projections for the business, to create a master budget. The master budget can also include figures for any financing that the company is expected to need over the coming year. As the year progresses, the projected budget and the actual money coming in and going out are monitored on a daily, weekly, or monthly basis, so that any deviations from the original budget can be identified, and, if necessary, remedied.

INCREMENTAL AND ZERO-BASED

There are two main approaches to setting budgets

Incremental budget

The budget for the year ahead is based on the previous year’s budget. This budget takes into account any changes, such as inflation, which could have an impact on the new calculations. The downside is that previous inaccuracies may be carried forward.

Zero-base budget

The coming year’s budget starts afresh, with no reference to previous years. This means that each item entered into the budget is carefully scrutinized and has to be justified by the department managers. This method makes it easier to see the full cost of all planned changes.

NEED TO KNOW

❯ Planning, Programming, and Budgeting Systems (PPBS) A budgeting system used in public service organizations such as city councils and hospitals
❯ Virement An amount saved under one cost heading in a budget is transferred to another cost heading to compensate for overspend
❯ Budget slack Deliberately underestimating sales or overestimating expenses in a budget

Setting and controlling budgets

Budget-setting is a process that takes place between the department managers, senior management, and finance department in a company to establish and control the cost of each department or project.

Consultation

Senior management sets out the company’s objectives to the departmental managers. Each manager is then responsible for working out the budget required by their individual department, in order to meet those objectives for the coming year.

Prepare the budget

The budget is usually based on the accounting year, but broken down into shorter periods. Departmental managers submit their budgets to senior management for approval. These may cover areas such as operating costs (salaries and supplies) and administration (office expenses).

Master budget

Once approved, the budgets from each department are combined into a master budget for the year, which includes: a budgeted profit-and-loss account, a projected balance sheet, and a budgeted cash-flow statement that typically shows a month-bymonth breakdown.

Measure performance

After each month (or equivalent time period set in the budget), the actual figures realized by the company are compared with the original budget projections. Variations are examined closely to work out whether they are significantly different from the figure in the original budget.

Take action

If necessary, the budget is revised to take into account any unforeseen and continued expenditure, or any savings that were not anticipated. If income is less than expected, action may be taken to alter departmental processes or campaigns in order to reach the targets set in the budget.