Importance of Business Budgeting, Essay Example

Budgeting is a way to maintain a financial plan that will ensure a directed path of a business. Planning and appropriate actions are one of the most important aspects of business decisions and without appropriate planning a business can fail miserably. By addressing the financial aspects, capital budget and marketing of a company, owners can ensure that they have addressed the foundation of the business. Without appropriate cash management a business has little direction and cannot sustain an appropriate financial path of survival.  Goals and objectives can be set to help maintain cash flow and create a financially sound plan for the company’s future and expansion. This paper will explore the definition of a budget, scorekeeping, attention directing, problem solving as well as types of budgeting.

Importance of Business Budgeting

A budget is a manner by which an individual or business can detail their expenses and revenues, as well as plan for saving and future spending (Sullivan & Sheffrin, 2003). It provides a way for a business to create an organizational plan that helps them manage their income, expenditures and even predict their future profit levels. A budget assists in maintaining a written record of all monetary transactions and helps plan for the future. A good budget provides goals and objectives that give the business a direction to follow in order to achieve success. Without that direction it is easy to stray from particular objectives, which can lead to too much or too little money being spent in the appropriate departments, projects therefore decreasing financial responsibility.

Budgets should be incorporated into any business, regardless of the size or amount of income that they have annually. Even the smallest businesses need to ensure that they are creating enough revenue to sustain continued production, salaries and expenditures. Without appropriate planning businesses can fail and in many cases is the mere reason that they struggle.

Budgets should be compared at minimum annually in order to compare projections, estimates and their actual numbers. This will provide a better projection for the next year and can also create some changes to move the business in the right direction. This can also make a difference not only in income, but also other issues such as tax strategies, savings and possibly even expansion into other markets or more profitable ventures.

Of course the biggest advantage to creating and maintaining a budget is to determine the profitability of the business; however there are several other benefits. The written plan and ability to see projections versus actual monetary movement in the company helps CEO’s make decisions and pay attention to the future of the business. They can create a detailed plan for anticipating the purpose and mission of the company. It also helps define areas within the business and their responsibilities for their piece of the budget. Targets can be used to determine the efficiency of a particular department or management team as well. The ability to forecast sales, expenditures and overall cash flow helps direct the business in a more productive manner. This way a business owner can create changes or make necessary plans for shortages or expansions that will help them grow their business. It can also assist them in sustaining through economic hardships or other problems that they may face throughout the year.

Scorekeeping – Attention Directing or Problem Solving

In order to maintain an effective business budget it is important to realize that financial focus can change, therefore leading to different methods of management. Problem solving is a way that management can assess and determine the impact of their financial decisions. They can compare two alternatives of financial decision and base their decisions on a projected outcome. In business there are many variables that can lead to great change and oftentimes lead managers to weigh options against one another.

Issues such as costs, rising production and other unforeseen problems can lead to drastic changes which can force budget planners to make decisions based on the best outcome for the business. The method of problem solving provides the ability to determine the best option and is oftentimes achieved through close monitoring and engaging in a special study. Because financial decisions have a large impact on the overall success of a business, sometimes a special study will be used in the problem solving phase to determine the best choice for the business.

Scorekeeping is a method that details the actions of the business. This method is the accumulation and classification of financial data (Curristine, Lonti & Journard, 2007).

This is a good way for the business to review the results of their financial decisions, however does not detail the financial path in which they are headed or where they have been. Scorekeeping budgets are sometimes used to gauge the variation of financial decisions and changes to the company’s financial baseline. This type of measurement and determination of the difference of variation is especially true in public governments.

Attention directing allows companies to focus on problems at hand and determine the most pressing of the financial needs. Because the market is ever changing it is important that managers be able to address deficits or problems within their budget. Attention directing is more concerned with reporting and interpreting information that focuses on the actual problems within the organization (Lamb, 1984). Addressing issues such as operating problems or deficits is sometimes noted in companies and can be addressed by detailing the actual budget needs or problems rather than the overall needs of the budget.

While a budget generally takes a specific focus all of these methods can be used to maintain the budget and ensure the overall success of the business.

There are situations and circumstances in which each method could be used to determine problems, refocus on necessary solutions to correct issues and also determine which direction is the best one to take for a particular situation. A budget is not limited to one method, however many run through problem solving, as there can be a number of changes within a financial budget that create issues that must be addressed.

Budgeted Performance Is Better Than Past Performance

Budgeted performance is said to be better than past performance simply for the control and results that managers can draw from. While history does commonly repeat itself there can be many variations that could skew results based on a past performance budget. The same economic conditions or environment may not be at play and can greatly reduce the effectiveness of a past performance budget. Past performance budgeting can vary for many reasons, but some can include the actual management of the budget, as well as unforeseen expenditures. Markets change, just as the cost of production can increase therefore making past performance out of date. Budgeted performances allow a more flexible financial environment for managers and allow them to have a better understanding of goals and the programs in which they are responsible for (Curristine, Lonti & Journard, 2007). Allocated resources can be explained in a specific manner and not referred back to a previous baseline or budgetary restricted environment.

Because budgeted performance is based on missions, goals and objectives managers are more able to explain their results and make changes if necessary. This is a positive for business for example when there is a problem with a company’s operating budget. Having a shortage of cash flow in a particular department or project can create a big problem for the budget; however a performance budget may appear to be acceptable, when it’s not.

Having the flexibility provides the ability to correct the deficit and focus more on planning, which creates a more focused understanding of the direction of the budget goals.

Difference between Strategic Planning & Budgeting Process

While strategic planning and the budgeting process generally go hand in hand there are some substantial differences. Strategic planning entails the allocation of resources in order for the business to be able to achieve their goals (Lamb, 1984). This is generally where strategies are determined therefore detailing how the business plans to achieve their goals. While these plans encompass the budget and monetary decisions, it is based more on the overall mission of the business, not only the financial aspect. A budget is the businesses plan for their financial direction, goals and objectives. This is where monies are allotted and determined based on a particular department, project or need. The budget involves the reporting and analysis of financial matters to determine the best course of action and analyze the data for necessary changes.

In conclusion, a business’s budget is an extremely important tool for business owners. Regardless of the size of the business they should engage in a budget to ensure that they are meeting needs, as well as preparing for the future. Without appropriate planning and oversight it is easy for a business to fall in a practice of struggle, which can eventually lead to financial demise. While there are a number of methods and types of budget practices, it is important for businesses to be aware that they may need to use more than one method to ensure that they are addressing their financial needs and goals.

References

Curristine, T.,  Lonti, Z.,  and  Joumard, I. (2007), “Improving Public Sector Efficiency: Challenges and Opportunities”, OECD Journal on Budgeting, 7(1), pp. 161-201.

Lamb, R.B. Competitive strategic management, Englewood Cliffs, NJ: Prentice-Hall, 1984

Sullivan, A., Sheffrin, S. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall, p. 502.