7.03 Manage financial resources to ensure solvency. Describe the nature of budgets (FI:106, FI LAP 3)

Define the term budgets. Budgeting is the process of predicting and controlling the spending of money within the organization and consists of a periodic negotiation cycle to set budgets (usually annual) and the day-to-day monitoring of current budgets. Business budgeting is a basic and essential process that allows businesses to attain many goals in one course of action. There are several goals that many businesses seek to achieve (or should be trying to work toward) when they create and implement a budget. These goals include control and evaluation, planning, communication, and motivation.

Explain why budgets are about money. Budgets relate to profit and loss, balance sheet, cash flow, payroll, capital expenses, revenue, and projects & expenses. With the budgeting process you can turn to the numbers and see how your spending breaks down into categories.

Describe how budgets are financial maps. After starting a business firm, it is your duty to map and supervise its financial position. Budgeting is the most efficient tool, which keeps your business and its finances at right path. - It is prepared in advance for keeping an eye on a future plan. - It is based on objectives to be achieved in future. - It is a financial statement prepared for the implementation of plan developed by the management.

Identify reasons that budgets are management tools. Although business budgeting is a procedure that most businesses go through, it can be a greater tool than many people (and businesses) realize. The budgeting process can allow companies to communicate and achieve their goals, and allow them to monitor those achievements as well. It is also an important step in overall business strategic planning. The act of budgeting for your business forces you to think through all the important numbers and to develop a picture of what your business is going to look like in three, six, nine and 12 months. A budget is a powerful business tool that will help you make better decisions. It enables you to develop and maintain a thorough understanding of the internal financial workings of your business.

Identify ways that businesses can create budgets. Sales Budget - The sales budget is an estimate of future sales, often broken down into both units and dollars. It is used to create company sales goals. Production Budget - Product oriented companies create a production budget. It is an estimate of the number of units that must be manufactured in order to meet the sales goals. The production budget also estimates the various costs involved with manufacturing those units, such as labor, material, and other expenses. Cash Flow Budget - The cash flow budget is a prediction of future cash receipts and expenditures for a particular time period. It usually covers a period in the short term future. The cash flow budget helps the business determine when income will be sufficient to cover expenses and when the company will need to seek outside financing. Marketing Budget - The marketing budget is an estimate of the funds needed for promotion, advertising, and public relations in order to market the product or service. Project Budget - The project budget is a prediction of the costs associated with a particular company project. These costs include labor, materials, and other related expenses. The project budget is often broken down into specific tasks, with task budgets assigned to each. Capital Budget - The capital budget is a prediction of company needs in regard to fixed assets, such as buildings, vehicles, machinery, and other equipment. It includes the cost of upgrading present assets, the cost of acquiring new assets, costs associated with maintenance of the assets, and fees associated with the assets. The capital budget helps the company plan for the acquisition and upkeep of these assets, which may include use of available cash or outside financing. Master Budget - The master budget is a summary of the plans created for the subunits of the company. It is used to create projected financial statements. The master budget results in the creation of a pro forma income statement and a pro forma balance sheet. These are also referred to as a budgeted income statement and a budgeted balance sheet. Potential investors and lenders want to see the projected financial statements in order to make decisions that will ultimately affect the company.

Explain the importance of budgets to business success. Budgeting allows a company to have a certain degree of control over costs, such as not allowing many types of expenses to take place if they were not budgeted for, or assigning responsibility for these expenses. A budget also gives a company a benchmark by which to evaluate business units, departments, and even individual managers. Budgeting allows a business to take stock of revenue and expenses from the previous period, and judge where the business will be in future periods. It also allows the organization to add and remove products and services from its plan for the future period. In larger organizations, the budgeting process may be completed by individual business units and compiled to form a master budget for the organization. This allows top management to get a picture of the entire business so they are able to better plan accordingly. Budgets allow management to communicate goals and to promote goal congruence so resources can be coordinated and focused in key areas. Budgets also allow a company to motivate its employees by involving them in the budget. While top-down budgeting does not accomplish this goal very effectively, participative budgeting can be motivating. When an employee is involved in creating his or her department’s budget, that person will be more likely to strive to achieve that budget.

Distinguish between general and specialized budgets. General Budget - A standard operational budget. This kind of budget is part of the yearly financial management of an operating business. Specialized budgets – are for specific purposes for a shorter period of time and are part the overall general budget, such as Sales Budget, Production Budget, Marketing Budget, Project Budget, etc.

Describe characteristics of a successful budget A basic business budget contains four major numbers: projected sales and revenue; projected total costs of achieving that level of sales and revenue; the profit or loss from operations. It should cover 12 to 24 months of business operation. You should work out a complete budget before beginning business operations. Each month, you should review, revise and update your budgets for the next 12 months.

Student Activity Students are to read the article “Why Budgeting Kills Your Company”, found at http://hbswk.hbs.edu/item/3623.html After studying the article, each student should write a short paper in which s/he discusses the pros and cons of budgeting and summarizes different experts’ suggestions regarding overhauling the budgeting process