Question

Budgeting allows for a company to set parameters for operations during a specific time period. There are many uses for a budget within a company or department. Provide examples of how a budget might be used in business and how decision making is affected by the use of a budget.

Answer 1

Business Budgeting

When most people think of budgets, they think of a typical household budget – given a certain amount of money, how much should be allocated to various expenses? This system usually works fine for individuals, but in the business world there needs to be a lot more involved. Determining how much to spend on various expenses is only half the battle. The other half is for a company to be able to effectively judge its spending financial performance. Regardless of the type of business, the ability to gauge performance using budgets is a matter of life and death in the business world.

Who Uses Budgets?

Nearly everyone uses budgets in some form. From the household budget to the multi-billion dollar government budgets, they're a pretty universal tool.

However, a company's budget is a bit more involved. Most companies will start with a master, or static, budget. A static budget is a budget with numbers based on planned outputs and inputs for each of the firm's divisions. It's the first part of budgeting, which determines how much a company has and how much it will spend. These are projected amounts and the company expects to stay within these limits. To figure out the numbers, managers make use of economic forecasting methods to determine a realistic static budget.

Changing Budgets

As you may have experienced with your own finances, expenses that are not part of the budget often pop up. However, the static budget acts as a guideline; it does not constrain the company to staying within those limits.

In other words, a budget is merely a tool that is used to help make business decisions. When it comes down to something that wasn't foreseen when the static budget was put together, companies can decide to spend more money or to spend more of it in a different area than originally planned, although the static budget will still act as a guideline. Budgets can always be changed.

Using a Budget to Evaluate Performance

So, what happens when the period's over? It's time to determine whether we fell in line with our planned expenditures. That's when a flexible budget is used. A flexible budget is a budget with figures that are based on actual output. It's then compared to a company's static budget to get variances (differences) between what level of spending was expected and what actually occurred.

With a flexible budget, budgeted dollar values (i.e. costs or selling prices) are multiplied by actual units to determine what particular number will be given to a level of output or sales. This yields the total variable costs involved in production. The second component of the flexible budget is the fixed cost. Typically, the fixed cost does not differ between the static and flexible budgets.

There are tons of variances that can arise in the static budgeting system. The two most basic are the flexible budget variance and sales-volume variance. The flexible budget variance compares the flexible budget to actual results to determine the effects that prices or costs have had on operations. The sales-volume variance compares the flexible budget to the static budget to determine the effect that a company's level of activity had on its operations.

From these two budgets, a company can develop individual flexible and static budgets for any element of its operations. For example, the static budget variance is the difference between the static budget and the company's actual results. The variances are always classified as either favorable or unfavorable.

If sales volume variance is unfavorable (flexible budget is less than static budget), the company's sales (or production with a production volume variance) will turn out to be less than anticipated. If, however, the flexible budget variance was unfavorable (the variance effects eventual cash flows negatively) this would be a result of price or cost. By knowing where the company is falling short or exceeding the mark, managers can do a better job of evaluating the company's performance and use the information to make changes to further streamline their processes.

Implementing Budgets

If you run your own business (or household), it's not hard to implement a flexible budget based on the business's numbers. You don't need to be an accountant: The math is simple and it's typically worth the effort in the end. After all, it's hard to know how you can make your company better and more cost-efficient when you don't even know where you're missing the mark.

The Bottom Line

Every major company in the world uses flexible budgeting – and you can bet that there's a good reason for that. So the next time you think about budgeting, think beyond the static budget that most people are familiar with. Understanding flexible budgeting can help you gain a wealth of information through the analysis that budget variances afford to those who use them.

The budget is an essential part of a business plan when starting a new business. Once a business is established, budgeting becomes a regular task that normally occurs on a quarterly and/or annual basis, where the past quarter or year's budget is reviewed and budget projections are made for the next three or even five quarters or years.

The basic process of planning a budget involves listing the business's fixed and variable costs on a monthly basis and then deciding on an allocation of funds to reflect the business's goals. (For more on fixed and variable costs, see Breakeven Analysis.)

Businesses often use special types of budgets to assess specific areas of operation. A cash flow budget, for instance, projects your business's cash inflows and outflows over a certain period of time. Its main use is to predict your business's ability to take in more cash than it pays out.

Why Does Your Business Need a Budget?

Without a budget you may not know how your business is performing. A budget provides an accurate picture of expenditures and revenues and should drive important business decisions such as whether to:

• increase marketing
• cut expenses
• hire staff
• purchase equipment
• improve efficiencies in other ways

A comprehensive budget will also be a definite requirement for obtaining business loans from financial institutions or seeking equity funding from investors.

Budget Expenses

Most businesses have fixed costs that are independent of sales revenue, such as:

• Building or office eases or mortgage costs
• Loan payments (if using debt financing)
• Insurance
• Vehicle leases (or loan payments if the vehicle is purchased)
• Equipment (machinery, tools, computers, etc.)
• Payroll (if employees are on salary)

• Utilities such as land line phone and internet charges

Variable costs increase or decrease according to the level of business activity. Examples include:

• Contractors' wages or commissions (for salespeople)
• Utilities costs that increase with activity - for example, electricity, gas, or water usage
• Raw materials
• Shipping and delivery costs
• Advertising (can be fixed or variable)
• Maintenance and repair of equipment

And if you're planning on starting a business, planning a budget plays an important role in determining your start up and operating costs. The Financial Plan Section of the Business Plan provides information on calculating your start up and operating expenses.

Business Budget Template Example

The following example demonstrates a simple business budget template. The example expenses listed are common to most small businesses. You can use and modify the template as required to suit your own business (select, cut & paste into a word processor or spreadsheet as required):

Acme Corporation 2018 Budget

Income	Actual	Budget	Difference
Operating Income
1st Quarter Sales	$34,300.00	$35,000.00	-$700.00
2nd Quarter Sales	$35,250.00	$35,000.00	$250.00
3rd Quarter Sales	$31,300.00	$30,000.00	$1,300.00
4th Quarter Sales	$27,100.00	$25,000.00	-$900.00
Total Operating Income	$127,950.00	$125,000.00	$2,950.00
Non-Operating Income
Interest	$650.00	$600.00	$50.00
Other	$1020.00	$500.00	$520.00
Total Non-Operating Income	$1,670.00	$1,100.00	$570.00
Total Income	$129,620.00	$126,100.00	$3,520.00
Expenses	Actual	Budget	Difference
Operating Expenses
Rent	$12,000.00	$12,000.00	-
Insurance	$2,500.00	$2,500.00	-
Electricity	$1,150.00	$1,100.00	$50.00
Gas	$1,250.00	$1,100.00	$150.00
Internet	$600.00	$600.00	-
Phone	$2,200.00	$1,900.00	$300.00
Travel	$2,300.00	$2,100.00	$200.00
Salaries, Wages, and Benefits	$66,000.00	$60,000.00	$6,000.00
Advertising	$1,200.00	$1,000.00	$200.00
License Fees	$500.00	$500.00	-
Office Supplies	$430.00	$500.00	-$70.00
Shipping and Delivery	$850.00	$1,000.00	-$150.00
Maintenance and Repairs	$1,100.00	$1,500.00	-$400.00
Other	$800.00	$1000.00	-$200.00
Total Operating Expenses	$92,880.00	$86,800.00	$6,080.00
Non-Operating Expenses
Smartphones	$1,800.00	$2,000.00	-$200.00
Tablets	$1,500.00	$2,000.00	-$500.00
Total Non-Operating Expenses	$3,300.00	$4,000.00	-$700.00
Total Expenses	$96,180.00	$90,800.00	$5,380.00
Net Income	$33,440.00	$35,300.00	-$1,900.00

Note that most accounting software has options for budgeting/forecasting (see Before You Buy Accounting Software for Your Small Business, 6 Advantages of Using Small Business Accounting Software, Best Small Business Accounting Software)

Making Budget Estimates

It is important to be realistic with your budget projections - if in doubt be conservative and overestimate your expenses and underestimate your revenues. It is particularly difficult if you are starting a new business and have no previous year's budget figures to guide your estimates - in this case it is typically much easier to estimate expenses than revenues.

As the budget year progresses the estimates should be updated monthly with actual figures, enabling you to check the accuracy of your forecasts. Note that there are often radical differences between actual and projected revenues and expenses due to unforeseen business circumstances and/or changing business and economic cycles, such as:

• gaining or losing a major client
• having to purchase or replace expense equipment
• an increase in rent
• hiring employees
• an increase in competition

decision making is affected by the use of a budget

Eliminating Emotionalism

You create your budget by sitting down in a rational moment and considering the best ways to spend your money. Numbers and facts guide this process. For example, if you know your income will allow for $25,000 of investment in marketing, recording this figure during the budgeting process keeps you from over-spending when a salesperson gets you excited about a media campaign.

Providing Balance

Your budget should consist of several smaller budgets. You need one for operating expenses, sales, purchases of new equipment and property, marketing, new hiring and production, to give a few examples. By looking at all of these areas of your business together, you can make wise decisions based on a balanced view of the needs of all aspects of your business. For example, if you overspend on hew hiring, you could have no money left for marketing.

Adjusting Strategy

Your budget tells you how you're doing. The foundation of your budget is your income. If you find that you are missing your income targets and have to cut back on expenditures, this tells you that you must make smarter decisions about where to focus your money. For example, missing income targets might cause you to reallocate funds for marketing and sales to boost income levels. Keep this strategy adjustment in mind when you create your next budget.

Built-in Growth

If you include plans for expansion and purchases of equipment and property in your budget, you include growth in your budget. Such a budget helps you focus on setting aside money for growing your business, not merely surviving. This focus makes your decisions wiser, because you not only watch your current bottom line, you plan to grow your income for your future bottom line.

There are other benefits of drawing up a business budget, including being better able to:

• manage your money effectively
• allocate appropriate resources to projects
• monitor performance
• meet your objectives
• improve decision-making
• identify problems before they occur - such as the need to raise finance or cash flow difficulties
• plan for the future
• increase staff motivation