Unit 2:


2.1 Introduction

Most successful companies today use operating budget to help them in their constant effort to analyze and control operations, keep cost in line, and reduce expense, many heads of households are familiar with the basic aspects of budgeting whereby they estimate their income for the following year, determine what their living expenses will be, and then, depending on the figures, reduce unnecessary spending, set up a savings plan, or possibly determine additional ways to supplement their income. During the year, they compare their budget with their actual income and expenditures to be sure that expenses do not exceed income and cause financial difficulties.


2.2 Meaning of Budgeting

A budget is the quantitative expression of a proposed plan of action by management for a future time period and is an aid to the coordination and implementation of the plan. A budget can cover both financial and non financial aspects of a plan and acts as a blue print for the organization to follow in the upcoming period.

Budgeting in business and industry is a formal method of detailed financial planning. It encompasses the coordination and control of every significant item in the balance sheet and income statement. Budgeting is used to help the company reach its long-term and short-term objectives. If the principles of budgeting are carried out in a proper manner, the company can be assured that it will efficiently use all of its resource and achieve the most favorable results possible in the long-run.


2.3 Essentials of BuDgeting

The general principles of budgeting have several requirements:

  1. Management must clearly define its objective.
  2. Goals must be realistic and possible to attain.
  3. Because the budgeting process involves looking to the future, the budget must carefully consider economic developments, the general business climate, and the conditions of the industry, along with changes and trends that may influence sales and costs.
  4. There must be a plan, which is consistently followed, to constantly analyze the actual results as compared with the budget.
  5. The budget must be flexible enough so that it can be modified in light of changing conditions.
  6. Responsible for forecasting costs must be clearly defined, and accountability for actual results must be enforced.


2.4 Objectives of Budgeting

Basically, the primary objective of any company is to maximize its net income or attain the highest volume of sales at the lowest possible cost. Planning and controlling are absolutely essential in achieving this goal, and budgeting produces the framework by which the organization can reach this objective. The budget then becomes a road map that guides managers along the way and let them know when the company is straying from its planned route. In addition to forecasting costs and profits as a means of cost control, the budget requires those in authority in all areas of business to carefully analyze all aspects of their responsibility for costs as well as to analyze company strength and weaknesses.

Based on the above objectives of budgeting, one can identify the following benefits of budgeting.

  • Budgeting translates policy into action.
  • It encourages delegation i.e., clear idea of what is expected from the members of the business.
  • It facilitates internal communication and co-ordinaiton.
  • It helps to establish standard of performance. Budget is an indicator of performance.
  • Forward planning focuses on operating problems early enough for action.
  • Budgeting facilitates process of change within the business.
  • Finally, it forces managers to become better administrators.


2.5 Limitations of Budgeting

As there are benefit, there are also some limitations in budgeting. The limitations are:

  • A budget cannot without effective organization information system.
  • Imposed budgets usually cause frustration and resentment.
  • It should only include controllable items.
  • Budget plans can become cumbersome/meaningless and/or inflexible when external factors change and internal decisions get modified.
  • Development of a new budge should include re-examination of standards.


2.6 Summary

The planning process is a means of communicating objectives and co-ordinating organizational activities in such a way as to meet those objectives. To this extent budgetary planning is a useful device but there is a danger that budgets can constrain the organization.

Often decisions have to be made which may alter the activities identified in the plan; provided such decision consider all of the issues involved, the budget should not be allowed to constrain the decision maker.


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