Budgeting – planning and development of budgets, activities within the planning stage of the budget process, the procedure for drawing up and adopting budgets, one of the components of the financial management system, designed for the optimal distribution of resources of an economic entity in time.
An enterprise budget is a quantitative plan, expressed in monetary units, prepared and approved for a certain period. It shows the goal – the planned amount of income and expenses that must be optimized during this period, as well as the amount of attracted capital required to achieve the goal. Enterprise budgeting allows you to systematize the planning process and efficiently monitor the financial and economic condition of the company. It is based on the preparation, external review, review, and approval of budgets.
Planning approaches depend on the size of the enterprise. Small companies in Moscow and other regions of Russia do not feel the need for long-term forecasting and planning as functions of business management. Often they make operational management decisions at the time of an external situation that can affect the performance. However, effective business management of an enterprise is impossible without planning, so even small businesses resort to drawing up short-term plans.
As the development progresses, the management processes at the enterprise become more complex, therefore it is necessary to carry out the budgeting process step by step. As the structure of the company becomes ramified, it becomes necessary to delegate authority to the heads of departments, which requires subsequent control over the performance of functions and a clear statement of tasks. How to start budgeting and planning in the enterprise?
Budgeting Objectives and Budgeting Functions
The main objectives of budget systems are coordination, resource allocation, performance evaluation, and overall budgetary planning of operations.
Companies use a budgeting system to plan for growth and business development over a period of time. The person in charge of the budgeting system uses budgets to identify opportunities and investments, as well as their cost. For example, if a pizza seller wants to expand franchise agreements, they must develop a budgeting system that shows the commercial space required for additional operations, the cost of training new owners, marketing costs, and the money required to purchase additional equipment.
Budgeting systems encourage managers and executives within the company to coordinate and keep costs within limits throughout the financial year. Without a budgeting system, managers have no restrictions on their actions or the actions of their employees. For example, the manager of one production department was able to use the entire payroll budget for his own needs, leaving the manager of another department without the opportunity to hire additional workers. The budgeting system requires managers to agree with each other and plan accordingly.
Efficient allocation of resources is one of the main goals that companies pursue when developing their budgeting systems. The company has a finite amount of capital and assets that it can spend on operations during the year. The budgeting system allocates resources throughout the company, setting aside sufficient capital for unexpected problems. For example, a company may lose inventory due to a natural disaster or some other problem. At the same time, in an effective budgeting system, capital will be allocated for such a force majeure, which will allow the company to buy more inventory without significant loss of income.
Managers use the company's budgeting system to determine if the company is performing effectively and within its allocated resources. For example, if a company's advertising department is consistently revising its budget, the analysis may show that the company is paying too much for advertisements in magazines. Budgeting systems set most of the financial metrics by which employees and managers are measured.
Different approaches to budgeting
There are different approaches to budgeting, for example, the exit/entry approach, the activity-based approach, the incremental approach, the “floor-level” approach, process budgeting, strategic budgeting, etc.
- The exit/entry approach
The output/input approach provides budgets for material costs and costs depending on the planned activities at the unit level. This approach is often used for services, merchandising, manufacturing, and distribution, where the balance between effort and achievement is the determining factor.
For example, if each production unit requires 2 packs of basic materials, which cost RUB 5,000, and the planned production volume is 25 units, the budgeted costs and costs of basic materials are 50 packs (25 units X 2 packs per unit) and 250,000 rub. (50 packs x 5 thousand rubles).
Budget receipts (“inputs”) depend on the planned results (“outputs”). The exit/entry approach starts with planned exits and then the entry budget is calculated in reverse order. The disadvantage of this approach is that it is difficult to use for costs that are not direct and do not depend on cost ratios at the unit level.
- Action-based approach
This approach is of an “in/out” type, but it reduces distortions in the transformation process by emphasizing the “expected value” of planned activities to be carried out for a process, department, service, product, or another budgetary goal. In this approach, overhead costs are budgeted based on the expected costs of various activities.
The value of each of the cost factors used in each budget task (for example, the budget for a product or service) is determined and multiplied by the cost per unit of cost. The result is an estimate of the costs for each product or service based on cost factors, as well as traditional volume-based factors such as direct labor or units of direct materials consumed.
The Basics of Action Budgeting involves forecasting the costs of budgetary goals using activity cost ratios that will affect the budget for each product or service. In evaluating the proposed budget, management should focus on identifying the optimal set of activities, not just the output/input relationship.
- The “floor” approach
As the proportion of non-variable costs increased for most companies throughout the twentieth century, an increasing proportion of costs were budgeted using a less precise phased approach. This means that there is no quality budgetary control of further cost increases. Management has attempted to improve cost control using a number of options for a phased approach. The floor-level approach is one attempt to control cost increases at the departmental level.
Using a flooring approach, the organization sets a baseline for budget items and requires explanation or justification for any budget amount that exceeds the minimum (baseline). This is likely to be the minimum amount needed to maintain the viability of a program or organizational unit.
For example, a corporate director of product development needs some base amount to avoid canceling ongoing projects. Also, additional amounts may be included in the enterprise budget, first to support the current level of product development, and then to implement new projects.