Meaning of budget?

A budget is a financial plan for a defined period of time, usually a year. It may also include
planned sales volumes and revenues, resource quantities, costs and expenses, assets,
liabilities and cash flows. Companies, governments, families and other organizations use it
to expresses strategic plans of activities or events in measurable terms.[1]
A budget is the sum of money allocated for a particular purpose and the summary of
intended expenditures along with proposals for how to meet them. It may include a budget
surplus, providing money for use at a future time, or a deficit in which expenses exceed
income.
Objectives of budget:

Many companies go through the budgeting process every year simply because they did
it the year before, but they do not know why they continue to create new budgets.
What are the objectives of budgeting? They are:

 Provide structure. A budget is especially useful for giving a company guidance regarding
the direction in which it is supposed to be going. Thus, it forms the basis for planning
what to do next. A CEO would be well advised to impose a budget on a company that
does not have a good sense of direction. Of course, a budget will not pro vide much
structure if the CEO promptly files away the budget and does not review it again until
the next year. A budget only provides a significant amount of structure when
management refers to it constantly, and judges employee performance based on the
expectations outlined within it.
 Predict cash flows. A budget is extremely useful in companies that are growing rapidly,
that have seasonal sales, or which have irregular sales patterns. These companies have
a difficult time estimating how much cash they are likely to have in the near term,
which results in periodic cash-related crises. A budget is useful for predicting cash
flows, but yields increasingly unreliable results further into the future. Thus, providing a
view of cash flows is only a reasonable budgeting objective if it covers the next few
months of the budget.
 Allocate resources. Some companies use the budgeting process as a tool for deciding
where to allocate funds to various activities, such as fixed asset purchases. Though a
valid objective, it should be combined with capacity constraint analysis (which is more
of an industrial engineering function than a financial function) to determine where
resources should really be allocated.
 Model scenarios. If a company is faced with a number of possible paths down which it
can travel, you can create a set of budgets, each based on different scenarios, to
estimate the financial results of each strategic direction. Though useful, this objective
 can result in highly unlikely results if management lets itself become overly optimistic in
inputting assumptions into the budget model.
 Measure performance. A common objective in creating a budget is to use it as the basis
for judging employee performance, through the use of variances from the budget. This
is a treacherous objective, since employees attempt to modify the budget to make their
personal objectives easier to achieve (known as budgetary slack).

Benefits of budgeting:

The advantages of budgeting include:

 Planning orientation. The process of creating a budget takes management away from its
short-term, day-to-day management of the business and forces it to think longer-term.
This is the chief goal of budgeting, even if management does not succeed in meeting its
goals as outlined in the budget - at least it is thinking about the company's competitive
and financial position and how to improve it.
 Profitability review. It is easy to lose sight of where a company is making most of its
money, during the scramble of day-to-day management. A properly structured budget
points out what aspects of the business produce money and which ones use it, which
forces management to consider whether it should drop some parts of the business, or
expand in others.
 Assumptions review. The budgeting process forces management to think about why the
company is in business, as well as its key assumptions about its business environment.
A periodic re-evaluation of these issues may result in altered assumptions, which may in
turn alter the way in which management decides to operate the business.
 Performance evaluations. You can work with employees to set up their goals for a
budgeting period, and possibly also tie bonuses or other incentives to how they
perform. You can then create budget versus actual reports to give employees feedback
regarding how they are progressing toward their goals. This approach is most common
with financial goals, though operational goals (such as reducing the product rework
rate) can also be added to the budget for performance appraisal purposes. This system
of evaluation is called responsibility accounting.
 Funding planning. A properly structured budget should derive the amount of cash that
will be spun off or which will be needed to support operations. This information is used
by the treasurer to plan for the company's funding needs.
 Cash allocation. There is only a limited amount of cash available to invest in fixed assets
and working capital, and the budgeting process forces management to decide which
assets are most worth investing in.
 Bottleneck analysis. Nearly every company has a bottleneck somewhere, and the
budgeting process can be used to concentrate on what can be done to either expand
the capacity of that bottleneck or to shift work around it.

Elements of budgeting

A budget is defined as a “comprehensive and coordinated plan, expressed in financial

terms, for the operations and resources, of an enterprise for some specified period in the
future”. —J.M. Fremgen.
According to the above definition, the essential elements of a budget that average are:
(i) Plan;

ADVERTISEMENTS:

(ii) Operations and resources;

(iii) Financial terms;

(iv) Specified future period;

(v) Comprehensiveness;

(vi) Coordination.

Plan:
The term ‘plan’ with reference to budgeting has a specific connotation. Budgetary plan
includes two aspects which have a bearing on the operations of an enterprise. One set of
factors that determine a firm’s future operations are wholly external and beyond firm’s
control like general business conditions, government policy and size and composition of
population.

The second set of factors that affect future activities are within the firm’s control and
discretion, i.e., they are internal like promotional programmes, manufacturing processes
etc. Thus, budgeting not only suggests what will happen but should also make things
happen. A budget is an expression partly of what the management expects to happen and
partly of what the management intends to happen.
Operations and Resources:
A budget is a mechanism to plan for the firm’s operations and resources. A budget should
qualify the revenues to be realised from products/services and the expenses to be incurred
on goods or services used in generating revenues. It also covers the resources of the firm.
The budget makes plan for various assets to be used in its operations and the sources of
funds to finance the assets both fixed and current assets.

Financial Terms:
Budgets are always prepared in financial terms i.e., in terms of monetary value such as
rupee, dollar, sterling etc.

Specified Future Period:

Budget is prepared for a specified period of time, usually for a year. Sales budget,
production budget, cash budget are all prepared for a financial period of one year.

Comprehensiveness:
A budget is comprehensive i.e., all the activities and operations of an organisation are
included in the budget. Budgets are prepared for each segment, facet, activity, division’ of
an organisation. These activities, segments are integrated into an overall budget for the
entire organisation. This overall budget is known as master budget.

Coordination:
The budget coordinates the various operational activities of an enterprise so as to take care
of the situations and problems of each component. The budgets for each of the components
are prepared in harmony with each other to make budgets more effective and meaningful.

What is forecasting:

A planning tool that helps management in its attempts to cope with the uncertainty of the future,
relying mainly on data from the past and present and analysis of trends.
Forecasting starts with certain assumptions based on the management's experience, knowledge,
and judgment. These estimates are projected into the coming months or years using one or more
techniques such as Box-Jenkins models, Delphi method, exponential smoothing, moving
averages, regression analysis, and trend projection. Since any error in the assumptions will result
in a similar or magnified error in forecasting, the technique of sensitivity analysis is used which
assigns a range of values to the uncertain factors (variables).

Read more: http://www.businessdictionary.com/definition/forecasting.html

 The difference between a budget
and a forecast
August 22, 2017

In essence, a budget is a quantified expectation for what a business wants to achieve.

Its characteristics are:

 The budget is a detailed representation of the future results, financial position,

and cash flows that management wants the business to achieve during a certain period
of time.
 The budget may only be updated once a year, depending on how frequently senior
management wants to revise information.
 The budget is compared to actual results to determine variances from expected
performance.
 Management takes remedial steps to bring actual results back into line with the budget.
 The budget to actual comparison can trigger changes in performance-based
compensation paid to employees.

Conversely, a forecast is an estimate of what will actually be achieved. Its

characteristics are:

 The forecast is typically limited to major revenue and expense line items. There is
usually no forecast for financial position, though cash flows may be forecasted.
 The forecast is updated at regular intervals, perhaps monthly or quarterly.
 The forecast may be used for short-term operational considerations, such as
adjustments to staffing, inventory levels, and the production plan.
 There is no variance analysis that compares the forecast to actual results.
 Changes in the forecast do not impact performance-based compensation paid to
employees.

Thus, the key difference between a budget and a forecast is that the budget is a plan for
where a business wants to go, while a forecast is the indication of where it is actually
going.
Realistically, the more useful of these tools is the forecast, for it gives a short-term
representation of the actual circumstances in which a business finds itself. The
information in a forecast can be used to take immediate action. A budget, on the other
hand, may contain targets that are simply not achievable, or for which market
circumstances have changed so much that it is not wise to attempt to achieve. If a
budget is to be used, it should at least be updated more frequently than once a year, so
that it bears some relationship to current market realities. The last poin t is of
particular importance in a rapidly-changing market, where the assumptions used to
create a budget may be rendered obsolete within a few months.

In short, a business always needs a forecast to reveal its current direction, while the
use of a budget is not always necessary.