Budgeting Process – Steps and Importance of Budget

What is a budget and budgeting process?

A budget is a tool for planning, implementing, and controlling activities for optimum utilization of scarce resources in a business. It explains the company’s objectives and the course of action it will choose to achieve its goals in detail. Also, it mentions the controls to be put in place for achieving its successful implementation. The budgeting process is the process of putting a budget in place. This process involves planning and forecasting, implementing, monitoring and controlling, and finally evaluating the performance of the budget.

A budget is essential for any organization. It helps to keep track of its income and expenditure. Performance evaluation becomes easy as there is a set target or goal to achieve in the budget for the pre-determined period. The management can question any deviation from the set goals. The budgeting process helps to take corrective action timely in cases of under-achievement of income or excessive expenditure. Thus, the budget helps to ascertain that business money is being spent and invested correctly, and the financial goals of the business are achieved.

What are the approaches to the budgeting process?

There are two main approaches to the budgeting process. These are:

Top-down approach

This budgeting process involves preparing the budget by the company’s senior management based on the company’s objectives. The departmental managers are assigned the responsibility for its successful implementation. Every department can opt to create its own budget based on the company’s broader budget allocation and goals.

This approach’s advantage is that the lower management saves a lot of time and gets a readymade budget to be followed. They hardly participate in the preparation of the central budget. The senior managers’ experience, coupled with past-performance figures, comes in handy in such budgeting processes.

Bottom-up approach

This budgeting process starts at the departmental level and moves up to higher levels. Every department within the company is required to prepare plans for its proposed activities for the next budget period and estimate the costs it will incur. These individual budgets are combined to create a bigger all-inclusive budget.

The budgeting process with this approach can be lengthy and time-consuming. However, employees and managers are more motivated to achieve the budget goals since they have prepared it. They have the complete knowledge of what the budget actually expects them to do and how to achieve that. Such budgets tend to be more accurate and closer to the actual situation on the ground.

What are the steps in the budgeting process?

Preparing the base for the budget according to funding:

The first step in preparing a budget is to identify the budget goals and how they will be achieved. Factors such as the business’s socio-economic surroundings, sales trends, etc. have to be taken into consideration for setting the goals. Also, these goals have to be set according to the economic resources available to the company. A budget will be of no use without proper funding.

Creating a cost buffer:

The next step in a budget is to scrutinize the costing for the business. Also, evaluating factors that can affect input costs during the budget period has to be done. Revision of the compensation plans of the employees takes place every year in most of the companies. Proper provisions should be created for variations in these costs and compensation plans to make the budget realistic and achievable.

Preparation of revenue and expenditure budgets:

The next important step is to prepare different types of subsidiary budgets for the organization. Proper and realistic forecasts for the different types of budgets such as sales, production, cash, purchase, labor and overheads, selling, general and administrative expenses have to be made. A realistic plan for the sources of revenue is the need for the budget period. Planning of expenditure should be accordingly as the company cannot spend more than what it earns. Thus, the revenue target decides and dictates the expected quantum of expenses to achieve these revenue targets.

Budgeting Process

Incorporating departmental budgets:

Smaller departments prepare their own budget in many companies. In such cases, their collection and integration, along with the master budget, is a pre-requisite.

Incorporating bonuses:

Most of the companies have the policy of declaring bonuses for their employees at the end of the financial year as per its financial results. Many may declare mid-year bonuses in case of exceptional performances. Such expenses can become significant in the case of big companies. Hence, due provisions have to be made in the budget for such unplanned giveaways.

Provision for capital expenditure:

A company may plan to incur a capital expenditure or invest in a fixed asset during the budget period. These expenses are quite heavy and considerable by nature. Hence, after consultation from the top management, their inclusion should be done in the budget.

Changes in the budget model and review:

After finalizing all the above steps, a review of the assumptions as per the budget model should be done. Also, a thorough review of the entire budget is essential. If there is a need for any changes in the budget, it can be done now.

Approval and implementation:

The budget will then go to the top management for approval. They will check if it is proper. Makers will make any changes as per need. In case everything is fine with the budget, they will give the go-ahead for implementation.

Budgetary controls:

The implementation of the budget is not the last step in the budgetary process. The setting of proper budgetary controls comes next. This is necessary for the comparison of the actual performance with the provisions and estimates of the budget. Continuous reporting of variances has to be done. The management can take corrective actions accordingly.

Importance of budgets

Proper funding according to targets

A budget sets targets for revenues and expenditure and helps to keep a check on both of them. Also, the management can channelize funding in the right direction as per the budget provisions. The formulation of proper strategies becomes possible as per the budget provisions. The management can also decide whether to go for capital expenditure or not as per the availability of financial resources looking at the budget.

Helps to set priorities

A budget helps to channelize resources across various departments as per the top management’s priorities and goals. They are in the best position to decide which department should get the maximum chunk of the budget allocation to grow. For example, there are times when the top management will feel that the products of the company have become obsolete and hence, are losing out to the competition. Hence, they may prefer to allocate a bigger portion of the budget to the research and development department to develop new and better products. This will help the company get back on track and again be ahead of the competition.

Controlled expenditure with better harmony

A budget helps to control wasteful expenditure in an organization. Because resources are scarce with any company. Hence, their allocation in the best possible manner is necessary for maximum returns. The budget guides the best possible utilization and allocation of resources. Moreover, it helps to maintain harmony between various departments of the business. Each department has a pre-determined share of the budget allocated to it. And it helps to take care of any daily arguments between them because of resource allocation.

Sanjay Bulaki Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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