Why Is Planning and Budgeting Important? [By Calista Halim]

What Is Planning and Budgeting?

A plan is forward looking and takes into account the variables that the management can control, such as financial resources, plant, property & equipment, and headcount. It begins with indicating the goals that a company wishes to achieve.

Thereafter, the management must budget accordingly in order to achieve those goals. Budgeting is the process of creating a quantitative plan to prioritise and manage a company’s expenditure of its resources. In other words, a budget is also known as the management’s quantitative interpretation of its plans.

When done properly, budgeting can serve as a tool for planning, involvement, and controlling. The company’s goals and performance are translated into quantitative terms, and can be controlled by comparing actual performance of a company to the budget. From there, it serves as one of the basis of performance evaluation and necessary fine-tuning actions.

Type of Budgets

The different type of budgets a company can create are:

  1. Master Budget summarises projected cash budget, budgeted income statement, and budgeted balance sheet. It also links budgets from various departments and usually used by the management to plan and set performance objectives.
  2. Operational Budget includes revenues and expenses from daily activities of the normal course of business. Revenues is the sales of goods and services, while expenses is the cost of sales and operating expenses.
  3. Cash Flow Budget examines the inflows and outflows of cash on a daily basis. It predicts a company’s ability to receive money faster from its customers than it pays out to its suppliers.
  4. Financial Budget shows how a business receives and spends money on a corporate level, including revenue and expenses from capital expenditures.
  5. Static Budget is where expenses remain constant even though there are variations in revenue. For instance, overhead fixed cost is a type of static budget.

Budgeting Methods

Incremental budgeting begins with previous period’s budget and adds incremental amounts, such as adjustments for inflation, for the new budget.

On the other side, zero-based budgeting does not take into account of previous period’s budget but instead it goes through every expenses that will be incurred. This forces managers to justify every revenue, cost of sales, and expenses in their department and failure to justify will result in zero allocation of resources.

Quick Steps In Creating a Budget

  1. Set financial goals. Every financial goal must be specific, measurable, achievable, relevant, and time framed
  2. Identify the personnel that are going to be involved in creating the budget
  3. Set a revenue budget that a company wishes to achieve
  4. Set cost of sales and operating expenses budget
  5. Consolidate revenue, cost of sales, and operating expenses budget amount to see the desired profitability
  6. Engage managers to review, monitor, and compare actual performance to the budgeted amount
  7. Identify the issues and action plans to resolve those issues
  8. Lastly, make any necessary adjustments to the budget

In Conclusion, Planning and Budgeting Is Indeed Important

  1. It helps to limit and control expenses to ensure that resources is not spent on unnecessary expenses.
  2. It helps to track expenses variances, where a monthly variance analysis will assist a company to understand where resources was spent on each month and in comparison to the sales level. Significant variances suggests that a company needs to revise their budgeting process to ensure a more accurate budget and projection.
  3. It helps to create a financial roadmap by reviewing previous period’s actual performance against the budget and use that as a basis to budget for future business growth and expansion.
  4. It helps to formalise the communication between various departments while working together towards a company’s goals.
  5. It helps to empower managers by involving them in decision making process and will create the opportunity for the department’s ideas to be heard.
  6. It serves as a performance evaluation tool to assess how well a department achieve its goal. Hence, encouraging the various departments to be more efficient and stringent in spending resources.

Overall, by creating and monitoring a budget periodically, not only it will help a company to work towards their goals, it will also help to review the actual performance of revenue, cost of sales, and expenses against its budgeted amount, which provides a quantitative picture to assist in creating action plans.

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