What is budgeting?

Basically, it's making sure that you're spending less than you're bringing in and
planning for both the short- and long-term.
ICMA International Capital Market Association defines budget as:
A budget is a quantitative statement, for a defined period of time, which may include planned revenues,
expenses, assets, liabilities and cash flows. A budget provides a focus for the organizations, aids in the
co-ordination of activities and facilitates control.

Unfortunately, many people think of budgeting as depriving themselves and they avoid it like they do a
diet. However, just like a diet is really just a program for eating, budgeting is just a program for spending. If
you are hitting a mental roadblock when you hear the word "budget", just call it by a different name, such
as "personal financial planning." That's what budgeting is, after all. It's a proactive approach, rather than a
reactive approach, to managing your money.
Budgeting is an important component of financial success. It's not difficult to implement, and it's not just
for people with limited funds. Budgeting makes it easier for people with incomes and expenses of all sizes
to make conscious decisions about how they'd prefer to allocate their money.

Advantages of Budgets
Provides a framework for judging performance
Motivates managers and other employees
Promotes coordination and communication among subunits within the company

Classification of Budget according to Time

When you are budgeting your money, you might want to think in the short-term, over the next few months, or in
the long-term, maybe over the next few years. This helps you to plan your finances and prepare for your future,
as well as your everyday expenses.

 Short Term Budget :

May cover periods of three to twelve months depending upon nature of business.
Short-term budgeting can help you cover everyday expenses, like food, transport costs or bills, as well as help
you buy small one-off things like birthday presents or CDs.

For eg: A budget allocated to manufacturing of lots for spring-summer season, Fashion
Retailing, etc
Long Term Budget :
A systematic and formalized process for directing & controlling operations for period
extending beyond one year
It proves useful in forecasting and evaluation of an organization over period of time. It
evaluates future implications associated with present decisions
A father planning money requirement for his childs future.
Classification of Budget according to Function
Sales Budget
The sales budget contains an itemization of a company's sales expectations for the budget period, in both
units and dollars. If a company has a large number of products, it usually aggregates its expected sales into a
smaller number of product categories or geographic regions. The sales budget is usually presented in either a
monthly or quarterly format; presenting only annual sales information is too aggregated, and so provides little
actionable information.
The marketing manager contributes sales promotion information, which can alter the timing and amount of
sales. The engineering and marketing managers may also contribute information about the introduction date
of new products, as well as the retirement date of old products. The chief executive officer may revise these
figures for the sales of any subsidiaries or product lines that the company plans to terminate or sell during the
budget period.
The basic calculation in the sales budget is to itemize the number of unit sales expected in one row, and then
list the average expected unit price in the next row, with the total revenues appearing in a third row.
Basically sales budget is a detailed schedule showing the expected sales for the coming year.
Sales forecasting:
Developing a sales budget requires forecasting future sales, which depends upon three main factors:
1. Information concerning past performance
2. Information about present conditions within industry and sales territory and
3. Data concerning the industry and general business conditions
Eg:

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Sales units

120

130

150

165

Price perunit

20

22

25

27

Totalsales

2400

2860

3750

4455

Yearly
565

13465

Production Budget
The production budget is prepared after the sales budget. The production budget lists the number of units
that must be produced during each budget period to meet sales needs and to provide for the desired ending
inventory.
The production budget calculates the number of units of products that must be manufactured, and is derived
from a combination of the sales forecast and the planned amount of finished goods inventory to have on hand
(usually as safety stock to cover for unexpected increases in demand). The production budget is typically
prepared for a "push" manufacturing system, as is used in a material requirements planning environment.

(I am repeating the point again) Basically: It specifies the number of units of each product that must be
produced to satisfy the sales forecast
The number of units to be produced can be formulated using:
Units to Produce = Budgeted sales + Desired closing inventory of finished goods Beginning inventory of
finished goods
E.g.
Budgeted sales = 70,000,
Desired closing finished goods inventory = 20,000
Beginning finished goods inventory = 40,000
Units to be produced = (70,000 + 20,000 40,000) = 50,000

Research and Development Budget

A tool for planning and controlling research and development costs

Helps in coordination with companys other plans and projects

Helps allocation of funds for R&D by coordinating companys immediate and long-term plans

Cash Budget
It contains details of cash inflows and cash outflows for the budget period of some other specific period.
This budget is used to ascertain whether company operations and other activities will provide a sufficient
amount of cash to meet projected cash requirements. If not, management must find additional funding
sources. The inputs to the cash budget come from several other budgets. The results of the cash budget are
used in the financing budget, which itemizes investments, debt, and both interest income and interest
expense.
Cash balances may fluctuate considerably within a single accounting period, thereby masking cash shortfalls
that can put a company in serious jeopardy.

Master Budget
It is summary or total budget package for a business firm
It can be called end product of budget making process
IT reveals the top managements goals of revenues, expenses, net income, cash inflows and financial positions
Takes the macro view of business and coordinates with production, raw materials, manpower and other
resources with production target.

Fixed Budget

A fixed budget is a financial plan that does not change through the budget period, irrespective of any changes
in actual activity levels experienced. Fixed budget is good for performance measurement, if output can be
estimated within close limits

Since most companies experience substantial variations from their expected activity levels over the period
encompassed by a budget, the amounts in the budget are likely to diverge from actual results. This divergence is
likely to increase over time. The only situations in which a fixed budget is likely to track close to actual results are
when:

Costs are largely fixed, so that expenses do not change as revenues fluctuate

The industry is not subject to much change, so that revenues are reasonably predictable

The company is in a monopoly situation, where customers must accept its pricing

Flexible Budget
A flexible budget calculates different expenditure levels for variable costs, depending upon changes in actual
revenue. The result is a budget that varies, depending on the activity levels experienced. You input the actual
revenues or other activity measures into the flexible budget once an accounting period has been completed,
and it generates a budget that is specific to the inputs.
Advantages of Flexible budgeting:
1. Accurate budgeting: Output factor is considered while preparation, since cost of goods may fluctuate time
to time

2. Coordination: Production is planned in relation to expected sales, materials and labor are acquired to meet
expected production requirements
3. Control tool: Comparison between the budgeted costs and actual costs form basis for analyzing cost
variances and fixing responsibility for same. This motivates managers to feel themselves motivated in
controlling costs for which they are responsible.

Zero Base Budgeting (ZBB)

A method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting
starts from a "zero base" and every function within an organization is analyzed for its needs and costs.
Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is
higher or lower than the previous one.
ZBB allows top-level strategic goals to be implemented into the budgeting process by tying them to specific
functional areas of the organization, where costs can be first grouped, then measured against previous results
and current expectations.
A zero-base budget requires managers to justify all of their budgeted expenditures, rather than the more
common approach of only requiring justification for incremental changes to the budget or the actual results
from the preceding year. Thus, a manager is theoretically assumed to have an expenditure base line of zero
(hence the name of the budgeting method).
The intent of the process is to continually refocus funding on key business objectives, and terminate or scale
back any activities no longer related to those objectives.
The basic process flow under zero-base budgeting is:
1.

Identify business objectives

2.

Create and evaluate alternative methods for accomplishing each objective

3.

Evaluate alternative funding levels, depending on planned performance levels

4.

Set priorities

ZBB rejects incremental nature of traditional budgeting, instead states that expenditure of each program must
start from base zero with each new budget being compiled as if the programs were being launched for first time

Advantages of ZBB:

It identifies and eliminates wastage and obsolete operations

Develops questioning attitude
Leads to staff involvement which may lead to improved motivation
Increases communication and coordination within organization

Required review. Using zero-base budgeting on a regular basis makes it more likely that all aspects of a
company will be examined periodically.

Resource allocation. If the process is conducted with the overall corporate mission and objectives in mind, an
organization should end up with strong targeting of funds in those areas where they are most needed.

In short, many of the advantages of zero-base budgeting focus on a strong, introspective look at the mission of a
business and exactly how the business is allocating its resources in order to achieve that mission.

Disadvantages of ZBB:
Cost involved in preparing a vast number of decision packages in large firm are very high
Time consuming and large amount of paperwork is involved
Managers may oppose new ideas and changes