process of budgeting in business as well as some of the potential benefits, drawbacks and limitations of budgeting:

this is one of two article that we’re doing on the topic of budgets and budgeting the other article looks at variance analysis and how you calculate variances. but this short article is all about an introduction to the process the concept of budgeting as a whole don’t forget with a budget. it’s all about looking forward looking at the future plan for a business as expressed by the revenues and the costs and therefore the profits of a business.

so a budget is a financial plan but it needs to be based around all aspects of the operations of the business not just the finances. i have mentioned that budgeting is a process typically it’s done each year and it’s a way in which financial control can be exercised by the management of a business.

therefore it’s a very important part of management control what we do is we establish budgets for revenues and for the cost of achieving those revenues. therefore if we’ve got revenues and costs what the profit of the business is going to be and then as we go through the year we compare actual performance with the budget to establish whether anything good has happened favorable variances or bad has happened adverse variances.

it’s those adverse variances that managers in particular need to take account of and investigate as they arise now budgeting is a very widely used process in businesses and the reason for this is that budgeting has lots of different uses you might want to pause the screen just for a second or two just to list down one or two of them onto your notes picking out.

i think some of the most important parts of budgeting i’d highlight this need for direction and coordination budgeting is a way of actually establishing the priorities of a business allocating resources and then monitoring performance there are three main types of budget we’ve mentioned them already the revenue sometimes otherwise known as the income budget which is all about the sales or the expected revenues and often this will be broken down into much more detail perhaps a budget by by location a budget by business unit or even a budget by product what you then do is you work out your cost budget and this should be based on the sales budget particularly applying variable costs to expected unit sales but also this is where we include our fixed costs the expected fixed costs the budgeted costs and lastly having done the revenue and cost budget.

we can then work out the profit budget there’s a process of putting a budget together and it’s on the screen there so again you may want to to pause the video just to note down some key features of the process i would highlight the importance of starting with a market-based budget there’s no point just drawing up a revenue budget based on last year you need to consider what’s changed how large is the market how fast has it grown or has it shrunk what’s our market share what are competitors doing all of these are factors that you need to consider as you then draw up your revenue budget a sales forecast or sales budget that’s based on the latest information is likely to be much more accurate and useful than one that’s based on outdated assumptions and similarly when we’re drawing up the cost budget.

we need to make sure that we allow for some contingencies some potential unexpected costs as well as factors that are in within our control that we know about for example changes in the prices charged to us by suppliers well budgets budgeting we’ve mentioned it’s a process and with all business processes whilst they have their advantages there are some potential drawbacks and some weaknesses some limitations let’s just look at the drawbacks first obviously sales forecasting is at the heart of a budget and where markets change rapidly for example through new technology or the the the actions of competitors then it makes sales a lot harder to forecast where demand is uncertain again that makes the sales revenue budget particularly difficult to put together.

so i think with all budgets you have to have an air of realism when putting them together similarly with costs as we know when we put our cost budget together something is always going to happen that which we didn’t anticipate and that could be good or bad news for example a good cost might be a new product that you launched that you weren’t expecting to launch in the original budget and similarly we need to be scanning the external environment to look out for changes which might affect our costs exchange rate changes is a great example of that so any budget will assume a certain level of exchange rates but of course in reality exchange rates will change during the course of the year.

therefore it’s just worth also noting down some of the limitations of budgeting that’s not to say that these mean that you don’t need to bother because clearly budgeting is a vital part of business activity and business management all businesses large and small will undertake budgeting and quite right too however the top point is a really valid one that your budget is only as good as the data that you use and the time that you invest into the budgeting process they do take time to complete and simply reporting actual results against budget whilst it yields some useful insights into variances it is also time consuming that’s why the use of accounting software that makes budgeting and variance analysis real time and done automatically is particularly useful for for all kinds of businesses there we go then that’s just been an introduction to the process of budgets and budgeting don’t forget to check out our video on how to calculate variances too