(This video chapter begins at 06:26 and ends at 07:50. Click on the blue dot at the 06:26 timestamp to play the video for this module.)

Understanding Budgets

Budgets are critical for businesses. Many stakeholders within the organization require that budgets be submitted for review every year. The budget sets spending limits and usually is broken down into the individual departments or business units. Typically, budget numbers are reviewed every month to determine how well the company is staying within the budget.

Understanding budgets will help you create and manage one for your areas or departments. Furthermore, knowing how a budget is formed will give you working knowledge that will increase your value to the organization.

Our focus quote for this module:

“A budget is just a method of worrying before you spend money, as well as afterward.“– Greg Anderson

In this module, you will learn the following on budgets:

• Common types of budgets
• What information do I need?
• Who should be involved?
• What should a budget look like?

Let us begin with the common types of budget.

Common Types of Budgets

There are six commonly used budget types for businesses. Here they are:

Sales budget: This budget estimates future sales. This is usually broken down into units and dollars. This budget is used to create company sales goals.

Production budget: This budget estimates the number of units that must be manufactured to meet sales goals. The production budget also estimates the various costs involved with manufacturing those units, which includes labor and materials.

Cash Flow/Cash budget: This budget predicts future cash receipts and expenditures for a particular time. It is usually for the short-term future. The cash flow budget helps businesses determine when income will be sufficient to cover expenses and when the company will need to get a loan to cover expenses during this time.

Marketing budget: This budget is an estimate of the funds needed for promotion, advertising, and public relations in order for the organization to market their product or service.

Project budget: This budget is a prediction of the costs associated with a particular project. These costs include labor, materials, and other related expenses. The project budget is often broken down into specific tasks called activities, with budgets assigned to each.

Expenditure budget: This budget estimates what expenses the organization will have for a time. This could include supplies for sale, office supplies, and bills.

Identifying Appropriate Situations

Accepting the situation is appropriate when:

• The task must be done eventually
• Avoiding or altering it would cause undue stress to you or another person
• Accepting the situation is not appropriate when:
• You are doing so just to please others
• Avoiding or altering it would reduce your stress more than accepting it
• You are accepting it because you feel you have no choice

What Information do I Need?

In order to begin a budget, you will need the following three pieces of information:

• Goal: Identifying a goal is the first step to creating a budget. Think about what you need to accomplish. This could be a sales goal, an efficiency goal or quality goal. No matter what the goal is, it is important to think carefully about the feasibility of the goal. Use the SMART technique for goal setting, which is making the goal Specific, Measurable, Attainable, Realistic, and Time driven.
• Money: How much money do you have? In the corporate environment, you may need to review the financial reports to determine how well the company is doing. When things are financially tight, the monies allocated to the budgets may be limited. Knowing how much is available will help you determine what you should request in terms of the business environment.
• Costs: You will need to determine how much the costs related to your goals will be. This may require you to breakdown your goals in to smaller components so you can put a price on each of them. Knowing how much things will cost will help weed out unnecessary expenses in your budget.

These three items will point you in the right direction when you are ready to begin your budget.

Who Should Be Involved?

Creating a budget is a challenging task especially when it is for the entire organization. The budget process will require input from many areas and departments. It will require strategic thinkers and people with the ability to determine what cost effective methods of doing things are.

In addition, people who know how to generate funds should be a part of the process. This will help to determine how much money the organization will need to make in order to meet budget goals.

When creating a budget for the organization, a team of people from various areas should be assembled. The team should include following areas:

• Accounting
• Operations
• Sales
• Top administration officials

Furthermore, these specific people should attend from each area mentioned:

• CEO
• CFO
• Finance manager
• Department leaders or directors
• Project managers
• A member of the Board of Directors

Once the members of the team are established they each should submit budgets from the areas they manager and direct.

The refining process usually involves the input from the CEO or CFO. Once the budget is set, the team can monitor the budget on a monthly basis to ensure each area is being held accountable to their budget for their area or department.

What Should a Budget Look Like?

A budget for an organization almost looks like an income statement, but with a few extra columns. A budget may be presented many ways. Some budgets present previous information from the past several years. Others only focus on the most current information.

Here is a basic outline of the categories of a budget:

• Categories: This column is on the left usually and it lists all the inflows, expenses, and net income categories. This can be general or very specific.
• Actual: This column is usually to the right of the categories column and contains the actual numbers that have been reported.
• Budget: This column is usually to the right of the Actual column. This column contains the budgeted numbers.
• Difference: This column is the last column on the right of the page. This column shows the difference from the budget.

This format can be expressed as a monthly report with year-to-date totals or it can be used as an end-of-year report. Other variations could be differences expressed in percentages.

Practical Illustration

Grant needed to create a budget for the department he oversaw. First he identified the goal of the budget, which was to increase the efficiency in the department. Next he reviewed the amount of money he had available to cover the costs associated with his goals. In order to increase efficiency, he needed to receive value for all money spent. To help him put together meaningful numbers, he consulted people who worked in accounting, operations, sales, and administration. He formatted the budget within preset parameters, then sent it to management for review. Grant had successfully drafted an efficient budget, which would help the company reach its goals.