Budgeting can be simply defined as balancing expenses with income. It is the process estimating revenue and expenses over a specified future period of time; it also involves compilation and re-evaluation on a periodic basis.
Budgets are important to help balance financial accounts, create and track business goals. Without proper budgeting a start-up might spend more than it earns and may eventually fail or become insolvent.
It is important for start-ups to have a budget that captures projected expenses and sales revenues. They can be used as a tools for comparison when evaluating their actual results of a year over the next fiscal year.
Budgets are also important for decision making and the efficient running of business. A budget should be ready for use by the beginning of the next fiscal year.
Budgets are prepared periodically and can be prepared for short, mid-range, longer term time periods e.g. weekly, monthly, quarterly or annually.
Creating budgets involve estimations, projections, evaluations and research. Typically, budgets help a business to forecast, plan, execute and then measure.
Preparing a budget
Preparing budgets involve making assumptions and projections for the period in question. These assumptions may include projected sales, projected revenue, projected costs and expenses, etc. When preparing a budget, the business also considers factors that affect the market or industry outlook and other socio-economic factors.
Budgets can be prepared for different departments of a business then rolled up into the master budget.
*Steps for preparing a budget*
The budget preparation process begins with reviewing the prior year’s budget and reviewing assumptions that were used as basis to prepare the previous year’s budget
The next step is to review factors that may affect current year sales or revenue and prescribe how this will affect the overall revenue for the year in view
Determine the budget period’s cost and expenses that are likely to be incurred during the period
Determine the likely amount of funding or funding limitations that will be available to the company during the period in view
Obtain service line or departmental budgets and adjust the budgets where necessary taking into consideration the sales forecast and funding assumptions gathered above
Input all budget information into the Master Budget Model
Review the budget with all departmental or service line heads, highlight any limitation or constraint issue and modify accordingly
Issue the Master Budget and distribute to all authorized personnel.
Zero-based budgeting vs. Traditional budgeting
A company can prepare its annual budget using any of the following methods.
Traditional budgeting – This method prepares the budget using incremental increases over previous budgets, such as a percentage increase in spending
Zero-based budgeting – This method involves preparing the budget using justification of both old and new expenses.
With traditional budgeting only new expenditures are analysed, whereas with zero-based budgeting the process starts from zero and calls for a justification of recurring expenses in addition to new expenditures.
Zero-based budgeting ensures justification of previous and recurring expenses, and aims to drive value for an organization by optimizing costs and not just revenue.
Types of budgets
There are different types of budgets but for the purpose of this article we will emphasize three types of budgets. They are:
Capital Budget: Capital budgeting involves budgeting for the firm’s fixed assets such as plant and equipment. It is the process of budgeting for, obtaining, expanding, and replacement of fixed assets.
Operating Budget: Operating budget emphasizes on the firm’s sales forecast. It is a budget of sales revenue minus expenses and essentially ends up with gross profit. Operating budget involves the business projecting what sales revenue it needs to attain in order to meet its expenses and achieve profit.
Cash Flow Budget: The cash flow budget is extremely important for a start-up business. It highlights the expected cash inflows (receipts) and cash outflows (expenses). The cash flow budget shows whether or not enough cash will be available to meet monthly expenses.
A budget may be surplus which means that profits are anticipated, or balanced which implies that revenues are expected to equal expenses, or deficit which means that expenses will exceed revenues.
When preparing a budget, remember to make allowances for unexpected expenses or revenue shortfalls.
Kaizer, Cicero & co is a business consulting and advisory services firm that helps organisations to solve issues, create value, maximize growth and improve business performance.