How it works
Every business needs to budget for anticipated
revenue and operating costs within the financial year.
Unlike capital budgeting, in which senior management
allocates what will be spent on specific projects or
assets, revenue budgeting focuses on the overall
projections for money coming in and money going out
for each month of the coming financial, or accounting,
year. Accountants compile operating budgets from
each manager in the business, along with expected
cash-flow projections for the business, to create a
master budget. The master budget can also include
figures for any financing that the company is expected
to need over the coming year. As the year progresses,
the projected budget and the actual money coming in
and going out are monitored on a daily, weekly, or
monthly basis, so that any deviations from the original
budget can be identified, and, if necessary, remedied.
Budgets
1%
of companies
worldwide made
accurate budget
forecasts, from
2004 to 2007
Setting and
controlling budgets
Budget-setting is a process that
takes place between the department
managers, senior management, and
finance department in a company to
establish and control the cost of each
department or project.
Setting the budget for a business involves planning the income and
expenditure for the accounting year. This is usually broken down into
months so that planned budget and actual figures can be compared.
Consultation
Senior management sets out
the company’s objectives to the
departmental managers. Each
manager is then responsible for
working out the budget required
by their individual department,
in order to meet those objectives
for the coming year.
Prepare the budget
The budget is usually based on the
accounting year, but broken down
into shorter periods. Departmental
managers submit their budgets to
senior management for approval.
These may cover areas such as
operating costs (salaries and supplies)
and administration (office expenses).
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How finance works
Management accounting
Planning, Programming, and Budgeting
Systems (PPBS) A budgeting system used
in public service organizations such as city
councils and hospitals
Virement An amount saved under one cost
heading in a budget is transferred to another
cost heading to compensate for overspend
Budget slack Deliberately underestimating
sales or overestimating expenses in a budget
There are two main approaches to setting budgets:
INCREMENTAL AND ZERO-BASED
NEED TO KNOW
Master budget
Once approved, the budgets from
each department are combined into
a master budget for the year, which
includes: a budgeted profit-and-loss
account, a projected balance sheet,
and a budgeted cash-flow statement
that typically shows a month-by-
month breakdown.
Measure performance
After each month (or equivalent time
period set in the budget), the actual
figures realized by the company are
compared with the original budget
projections. Variations are examined
closely to work out whether they are
significantly different from the figure
in the original budget.
Take action
If necessary, the budget is revised
to take into account any unforeseen
and continued expenditure, or any
savings that were not anticipated. If
income is less than expected, action
may be taken to alter departmental
processes or campaigns in order to
reach the targets set in the budget.
Incremental budget The
budget for the year ahead is
based on the previous year’s
budget. This budget takes
into account any changes,
such as inflation, which could
have an impact on the new
calculations. The downside
is that previous inaccuracies
may be carried forward.
Zero-base budget The coming
year’s budget starts afresh, with
no reference to previous years.
This means that each item
entered into the budget is
carefully scrutinized and has to
be justified by the department
managers. This method makes
it easier to see the full cost of all
planned changes.
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