What are the different types of budgets in business?
Budgeting is one of the critical aspects of assessing a company’s financial performance and profitability over the year.
It guides your spending nature, prevents you from overspending, and aligns your performance with your financial goals.
Through business budgets, companies focus on cost-cutting, identifying unwanted expenses, and comprehending if the budgets allocated are reliable or not.
Additionally, it helps prevent unforeseen circumstances and helps establish company-wide spend culture.
But budgeting cannot be done without having solid reports and advice.
The documents like financial statements, information, cash flow statements, and so on help provide a reasonable estimate of the accuracy of the company budget.
Budgeting is the process of creating business budgets that estimate the amount of money required to run business operations successfully.
It lays out the expenses the business might need to incur over a period of time, usually annually.
Based on budgets, departmental heads outline their financial goals, keeping in mind the funds allocated are put to judicious use.
They accordingly plan out the activities and determine the course of action that fits well within the budget walls.
If, in any case, the budget allocated is less than what is required, it should be duly communicated to the budgeting team along with reports supporting their motion.
After studying the reports and documents, the budgeting team decides whether to increase the budget or not.
It is always advisable to keep the budgets flexible. Having too rigid and unalterable budgets often limits creativity and narrows down the alternatives.
A budget is a business owner’s tool to understand how well the company might perform financially in the coming future.
It takes into account all the foreseen as well as unforeseen circumstances.
The budgets are an essential component of business planning. Therefore, cherishing them is in the best interest of the business.
Below mentioned are the reasons why budgeting is vital to companies as well as the employees
Businesses operate in a dynamic environment, constantly subjected to uncertainty and changes.
They have to deal with uncertainties of economic, social, legal, political, and technological dimensions. For example, businesses were highly impacted by the sudden advent of Covid-19.
Therefore, it's critically important to consider unforeseen future events and prepare the resources for them.
Through budgeting, companies can set aside a few funds in the general reserve to use during such circumstances so that the company doesn’t end up using the funds for business operations.
If you are a startup aiming to receive funding through venture capital or other financial institutions, your cash management reports like budgets and cash flow statements are critical.
These reports exhibit your cash spending habits.
The well-thought and implemented budget show the management's seriousness in controlling their expenses, how they plan to use the funds allocated to them, where they are willing to do cost-cutting, and which expenses need to be fully cleared out.
Many more questions are answered through budgets.
Every company has some financial goals to achieve.
Companies cannot recklessly keep spending funds and other resources without considering the after-effects of accomplishing those goals.
With the help of budgeting, companies can set realistic goals keeping in mind the available resources.
Also, it creates boundaries on how much they are allowed to spend.
Everything in business maps back to money.
Every decision, irrespective of its nature and purpose – requires investment.
The management is supposed to take calls of decision now and then; some might be well-planned while others can be on-the-spot.
An estimation of the monetary resources available can help improve the decision-making process.
With the amount of cash available, management can make decisions within their capabilities and ensure these decisions are not affecting other budgets.
For example- if there’s a new unit being set up, questions like these need to be thought through:
• How many wages need to be paid daily?
• What will be the estimated construction cost?
• Do the company’s sales cover all the costs?
With so much influx of money in and out of business, it is bound that some of the funds will be wasted or put to the wrong use( overspending on luxuries, unnecessary purchases).
And management cannot control every expense made by employees. But they can limit it to some extent.
The first step in ending the overspending is to – identify the areas where such mistakes are made.
Through budgeting, management knows how much has been spent behind which expense categories.
Sometimes, there’s an increase in cost due to overlapping activities between departments.
For example, the accounting department has failed to pay monthly EMI and interests, which led to penalties and late-payment fees.
Every business is unquestionably unique in its way. Hence, there’s no one-size-fits-all approach when it comes to budgeting. Different budget types cater to different business needs.
Broadly, there are eight different types of budgets. Some of them are:
The operating budget, or operational budget, is your budget that is used to make your business operations run smoothly.
It outlines the expenses which will be covered to keep your business generating revenue.
Generally, it includes fixed costs, variable costs, capital costs, and non-operating expenses.
The operating budget is prepared at the beginning of the financial year to ensure the business has enough resources to kick start the operations.
Also, this budget is kept quite flexible owing to the uncertainty of the business environment.
The next most crucial budget for an organization is its financial budget.
It estimates the company’s short-term and long-term financial obligations and the resources required to support these. Also, it includes the capital requirement of the business.
Companies make decisions on their assets, liabilities, and equity requirements through financial budgets.
How much they plan to increase their investments and equity and how much debt and liability they are willing to reduce.
A sales budget helps you estimate how much sales and revenue are projected from the upcoming year/quarter and which expenses might be recurring to support product sales.
This budget uses sales forecasting techniques to predict sales and expenses.
It includes all the components necessary to drive sales of the product.
The main element is inventory. It reflects how much stock is to be maintained in the business for an uninterrupted sales flow.
A cash flow budget or cash budget gives you an estimate of the cash inflow and outflow of the business for a given period of time. This budget is created based on past accounts receivable and payable performance.
This budget helps you know the business's liquidity at a specific time, how well the company can pay its financial obligations, and how efficiently it uses its resources.
Based on the sales budget, a production budget is prepared.
This budget deals with the availability of inventory and other raw materials to align with the sales budget.
Through production budget, the following things are determined:
• Labour strength.
• Raw materials and other resources.
• Overhead charges.
Generally, the production budget also affects the end price of the product, as the production costs are directly proportional to the product's final price.
Through the labor budget, you estimate the amount of labor or employee required for the given period of time.
It allows you to assess the workforce needed to fulfill your goals and determine their payroll.
The labour budget also helps in determining the effectiveness of the previous budget.
How much labor fell short or excess to catch up with the production, and what number of employees are required to achieve the goals quickly.
Static budgets are fixed or unaltered budgets. This budget spells out the revenue and expenses that shall remain fixed throughout the year, irrespective of whether the company is generating revenue.
Some examples of the line times in a static budget:
• Supply costs.
• Maintenance costs.
• Subscription fees.
• Contractor fees.
• Software installation.
Usually, corporations do not adopt static budgets due to their rigid nature. Education institutions, government agencies, and NGOs are required to use this budget for some of their activities.
A master budget is the conglomerate of all the individual budgets.
It depicts an accurate financial picture of the company using inputs from the financial statements, cash flow statements, and other forecasting reports.
Initially, the management drafts a master budget; based on this, different departmental budgets like sales production are created.
Master budgets are generally used by large corporations, considering their large department and a high number of employees.
Firstly, the goals to be achieved are decided in a master budget, then, later on, these are broken down into small goals by each department.
Budgeting is often overlooked as a back-office or secondary task.
Hence, many companies do not even draft a rough budget outline, considering it a waste of time and energy.
But in reality, these companies are exposing themselves to a significant threat by not doing so.
• Risks associated is no budget is created.
• No control over spending and departmental limits.
• Not having an emergency fund to protect from uncertainty.
• Limited opportunities for expansion.
• Difficulty in obtaining funding.
• Unrealistic approach toward long-term goals.
A budget lays down the map for success. It helps you understand your business better, know the areas of cash flow, and identify the loopholes in the processes.
Drafting a budget is a challenging task. It’s not simply framing based on your assumptions and predictions but involves a series of evaluations right from past performance to future expectations.
The manual budgeting process demands a lot of juggling between financial statements and reports, consultation with departments, and the opinions of a financial advisor and CFO.
Heavy dependence on manual budgeting calls for room for errors and wastage of time.
Companies now have shifted towards a more sophisticated means for drafting budgets and budgeting softwares.
This softwares lets you create budgets most efficiently and conveniently without running through multiple records.
Based on the previous performance, these softwares draft sample budgets which align with your financial goals.
Related read - How to do business budget planning for new fiscal year?