Budgeting for a business is a process. It is the process of preparing a detailed statement of financial results that are expected for a given time period in the future. There are two keywords in that statement. The first keyword is "expected." Expected means something that is likely to happen. The second keyword is "future" which is a period in the time to come. So, budgeting is the process of preparing a detailed statement of financial results that are likely to happen in a period in a time to come.
Budgeting Time Periods
Budgeting is usually prepared for short, mid-range, longer term time periods. A common set of time periods for budgeting might be a month, a quarter, and a year. It should develop sets of reasonable and attainable goals using data that need control (such as sales data). Budgeting tells the employees of the firms what their jobs are and how they are expected to perform them.
Budgeting and Financial Forecasting
Most budgets are a company's first step in financial forecasting. If you take your budgets a few steps forward, then you have financial statements forecasting the future. It is important to develop forward-looking balance sheets and cash flow statements as well as income statements. You may want to project your budgets forward 3 years and even 5 years. Obviously, those figures are forecasted and should be updated as your short-term budgets are developed.
Most business owners start out with budgets that project income and expenses and are, as a result, associated with the company's income statement. But, there are other types of budgeting that are necessary for a company. For example, you also have to budget based on the balance sheet. You need to project the levels of assets and liabilities you expect to have in the future.
With the regard to the statement of cash flows, it is particularly important with regard to budgeting. Projecting cash flows is important so you will know you are always in a positive cash flow position and can meet your short-term debt obligations. If you can develop good financial budgets, you can control your cash flow, which is of vital importance to your business firm if you want to pay your bills in a timely manner.
Types of Budgeting in a Business Firm
There are a number of types of budgets that business owners or managers need to do. Even though budgeting is of crucial importance to financial management, owners or managers need to recognize that they cannot get lost in the budgeting procedure at the expense of managing the firm. It depends on the needs and the complexities of the firm which types of budgets they need.
The three most important types of budgeting that a business firm should practice are capital budgeting, operating budgeting, and cash flow budgeting. Other types of budgeting are also important but these three are an excellent start:
Capital budgeting is budgeting for the large expenses in a business firm. Capital budgeting is budgeting for the fixed assets that the firm needs to work such as plant and equipment. It is the process of budgeting for, obtaining, expanding, and replacing fixed assets. Doing a good job budgeting for fixed assets like buildings, equipment, tools, and other fixed assets that last more than one year is important simply because they last a long time. If you make a mistake in capital budgeting, it will haunt you for a long time.
The operating budget is based primarily on the firm's sales forecast. It is a budget of sales revenue minus expenses and essentially ends up with gross profit. In the operating budget, you have to determine what you need in sales revenue to meet your expenses and achieve your profit goal.
The cash flow budget is incredibly important for the business firm. It is a budget showing expected cash inflows (receipts) and cash outflows (expenses). The cash flow budget shows whether or not enough cash will be available to meet monthly expenses. If not, the cash flow budget shows how you can borrow if you don't have enough money to meet expenses and how you can invest if you have more money than you need in a given month.
Budgeting is a necessary exercise in a business firm that should be performed in order to plan for the present and the future.
The long-term budget in XYZ, Inc. is the basis for their forecasting 3 years and 5 years out.