The strategic plan for the business firm maps out the firm's planned activities for five years in the future. The financial budget is not generally planned for that length of time. Generally, financial budgets are planned for one year. Firms may forecast budgets farther into the future if they are trying to get bank loans or some other form of financing, but for practical reasons, budgets can only be reasonably accurate for one years. Financial budgets reflect the firm's objectives which are tied to the firm's strategic plan. They also reflect the firm's business plan, particularly its business action plan.
What is the Purpose of the Financial Budget
The financial budget helps the firm in planning and control regarding its inflows and outflows of cash and its overall financial position. In comparison, the operating budget describe the income-generating activities of the firm. The operating budget is always prepared first because many of the financing activities are not known until the different operating budgets are known. For example, the sales budget and the production budget have to be known before the financial budget can be prepared.
Here is a financial budget for a small hospital. It gives you an example of just how complicated financial budgeting is. This budget even includes the operating budget even though it should be separate.
What do you Budget?
You will see many financial budget that budget only for the income statement. Even though interest expense comes from the financial budget, you do not just budget for the income statement. You also budget for the balance sheet. If you budget for both, you can see your cash flow needs for your entire operation. If you budget only for the income statement, you will also not take any capital expenditures you might need to make into consideration such as purchase of new plant and/or equipment. If you purchase new capital assets, you also have to budget for debt service on those assets.
The financial budget usually has three parts:
Sections of the Financial Budget
There are three sections to the financial budget:
This example shows you a typical cash budget with inflows, outflows, and net cash flows. Business firms can show a profit but fail because of the timing of their cash flows. Very small businesses are usually required to pay cash to their suppliers, but sell to their customers on credit. As a result, they often run into a cash flow problem. Developing a cash budget like you find in this example is the best way to keep track of your cash flows and know you can stay on track.
Business owners and financial managers should keep in mind that budgeting is not a static process but rather a dynamic process. When information about the firm's financial processes changes, it should be immediately reflected in the cash budget. Many firms use monthly cash budgets. Some find it more helpful to use weekly cash budgets and others even go with daily cash budgets.
The Budgeted Balance Sheet
The budgeted balance sheet is the product of a number of other budgets in the budgetary process; specifically, the production budget and its associated budgets.
Financial managers or business owners have to decide, from time to time, whether to replace plant and equipment or whether to buy new plant and equipment for growth. These are known as capital expenditures. Purchasing capital assets requires special consideration because they are large purchases, costing a lot of money, and lasting a number of years. Issues like time value of money and depreciation must be taken into consideration when considering whether or not to purchase capital assets. Usually, business firms have a capital expenditures budget that is developed for this purpose.