Introduction
Every business needs to have a financial record of its sales, costs, and revenues, among other monetary dealings, to evaluate its performance and future planning. The records can be monthly, annually, or for an organization’s particular period. Since most businesses face financial constraints as they grow, it is essential to have a financial plan for adjustments.
A budget is essential for planning and decision-making when starting and establishing businesses. Regardless of the size or nature, every organization needs a budget for financial planning. Businesses use different budgeting methods, such as line and program budgeting techniques, to record their income and expenses for financial planning. Depending on the budgeting method, organizations need to consider the associated assumptions for financial predictions and planning.
Types of Budgets
Businesses can use different budgets depending on their financial needs and size. Budgets vary according to their composition in terms of their financial records, adjustability based on ease of adjustment, roles, purposes, and size (Finkler et al., 2023). As a result, budgets are classified into many groups with various features. Similarly, the different classifications have various assumptions that must be considered for precise results.
Line-Item Budget
The budget compares the financial data for two periods, mostly the record with the current or future period. It describes the combinations of two items or market commodities that a consumer can afford and purchase within a specific period. Since affordability changes with income, a customer will likely increase or decrease their purchasing power when the income changes (Finkler et al., 2023).
Depending on the income change, there is likely to be a difference in consumption within a specific period for a customer. If the income rises, the affordability will increase and thus raise the purchasing power. Similarly, if the consumer income reduces, the affordability will decrease, lowering the purchasing power. The budget thus helps to compare the financial data or expenditures of the consumer for a specific time. Changes influence the line item in two factors: the consumer’s income and the commodity’s price. For precise results, the budget users should consider some assumptions.
Assumptions
Expense Similar to Income and Limited Income
Finally, the budget proponents assume that the spending reflects the consumer’s income. The customer will spend all their income to purchase the two commodities. The user assumes that a consumer does not save or use income on other activities but consumes all of it through spending on the purchase of the two items (Finkler et al., 2023). The limited income is all spent on purchasing two commodities. Secondly, a line-item budget assumes that a consumer has limited income and is interested in buying the two commodities.
Program Budget
The budget carries the financial records for particular business activities, including current and future expenditures. Coined from the word “program,” the budget features the financial planning for one or many closely related programs or activities (Finkler et al., 2023). The budget can be from a company’s department, highlighting the financial records and plans for the sector for a specific period.
Flexible Budget
From the term flexible, the budget can be adjusted depending on income, cost, and changes in business needs. Due to the cost dynamic, an organization may predict an upward or downward shift and thus anticipate adjustment. Similarly, a business may have some needs to consider in the future due to limited resources in the current financial planning and thus decide to have variable costs instead of hard numerical figures (Finkler et al., 2023). Flexible budgets can determine the contraction and expansion of financial plans in real-time. For precise results, the budget drafter should consider the affiliated assumptions.
Revenues and Cost Change
The budget proponents assume that revenue changes after some period. Revenue is anticipated to shift upwards or downwards, which may trigger an increase in expenditure. In addition, the upward shift in revenue may lead to the inclusion of some needs that were sidelined during the initial planning. Alternatively, a downward shift in revenue may lead to removing some expenditures from the budget.
Importance of Cash Flow
Businesses need some cash to run and operate. Thus, organizations must monitor and evaluate their cash needs in relation to available cash. Cash budgets demonstrate a business’s incoming and outgoing cash for a specific period, either monthly or annually. All enterprises, especially those that engage in daily operations and customer transactions, require a cash budget to monitor and understand cash and cash needs.
Second, cash flow helps estimate business expenses and adjust accordingly. An organization can use its cash budget to track down its expenses, identify areas where it engages in unnecessary spending, and cut off. Since a lean cash budget increases gross profit and vice versa, a business can use its cash flow to evaluate its performance and make the necessary changes where possible (Finkler et al., 2023). It is, therefore, important for businesses to have cash-flow budgets.
Important Reasons for Understanding the Operating Budget
Managing the Current Costs
The operating budget is essential in evaluating and managing overhead costs such as rent, power, and salaries. Understanding the overhead costs helps assess the business performance and make adjustments where necessary (Finkler et al., 2023). An operating budget can help an organization identify costs that overburden the business. For example, if a company realizes the salary expense is exaggerated, it can reduce the number of employees accordingly.
Projecting Future Expenses
Understanding past and current expenses can help draw the future budget. Since costs are mostly closely related, it is easier to project future costs and thus formulate the financial plan. For example, overhead costs such as salaries and rent rarely change; therefore, a business can use current expenses to draft the future budget. Similarly, knowledge from the previous operating budget, such as the deficit, is important in predicting future occurrences.
Increasing Accountability and Financial Discipline
Operating budgets show costs and expenses related to various aspects of the business. With this knowledge, it is easier to anticipate financial needs and expenses and set aside the right amount of revenue, thus reducing careless expenditures (Finkler et al., 2023). For example, an organization can project the expense of salaries and set the right amount of revenue. In addition, understanding the operating budget helps reduce deficits resulting from underquoting.
Conclusion
In summary, a budget is a critical financial planning and decision-making tool. For its financial planning, a business can use a flexible budget for adjustment, a program budget for interdependent activities, or a line-item budget that compares financial data within specific periods. In addition, a capital purchase is an asset valued above $5000$ that can be used long-term, such as an ambulance. Finally, it is essential to understand the operating budget for managing costs, projecting future budgets, and ensuring accountability and financial discipline.
References
Finkler, S, Thad D. Calabrese, & Daniel. (2023). Financial management for public health, and not for profit organizations. CQ Press
Dr. Routh, B. (2012). What is capital budgeting: Introduction – managerial accounting video [Video]. YouTube. Web.