Budgeting an important financial tool
What is budgeting? Basically, it is a program or a
systematic idea or scratch of your income and expenses. Unfortunately, many of
us ignore it as we think it is something can be done by themselves. Budgeting
is an important financial tool to find the area of our spending. It help us to
eliminate the useless cost factors which may cause to our low profit margin.
Budgeting makes it easier for us with incomes and expenses of all sizes to make
conscious decisions about how we'd prefer to allocate our money.
According to Wikipedia, “A budget is a quantitative
expression of a plan for a defined period of time. It may include planned sales
volumes and revenues, resource quantities, costs and expenses, assets,
liabilities and cash flows. It expresses strategic plans of business units,
organizations, activities or events in measurable terms.”
Help to plan
long-term and short term projections
Budget help us to plan our short-term expanses, like our
monthly bills or for mid-term expanses like our business tour or pleasure trip.
When it comes to longer period, its outcomes are amazing like buying a house or
planning for your retirement. It may be for a month to multiple years. When we
do budgeting, we always know how much money we will have at the end of each
month and when we need to pull our hand back.
“Think twice before you spend”
It prevent us from crises too. Future is totally unpredictable
and we may require liquid cash at any time in the near future, may be for some
health issues or for some damage due to natural disaster for an instance, due
to electric short circuit your house or factory caught fire and you lost
everything you have earned yet. Though you may have fire insurance, you're
still going to have to fork over at least $5000 out-of-pocket to get your place
to make it usable.
Budget also help you to plan any major changes. Budget lets
you model in advance how a major purchase or life changes will affect your bank
balance. A bachelor may live in an apartment but if want to tie the knot, he
has to buy a bigger flat. Instead of wondering if he can afford a house or
panicking about whether newlywed couple can afford to live on one income while
the other stays home to raise a child, he'll have the data he needs to crunch
the numbers.
Purpose of budgeting
Budget helps to aid planning of actual operations to
consider how macroeconomic environment may change and what step should be
taken. It help managers to be prepared against the problem before they arise.
It helps;
·
To control resources
·
To distribute the responsibility to concern
manager
·
To motivate people in order to achieve budgeted
target
·
To evaluate performance of management
·
To analyze the actual financial operation
against foretasted.
Type of budgets
There are two main type of budgeting; traditional and Zero based. In
traditional budget, analyst review the historical data and then projections of
such findings to the future with modifications. Historical sales patterns,
using established trends in sales growth, are projected; new sales from planned
new product introductions are then added.
Zero based budgeting is the model of completely new budget
from scratch as if there were no history. When using this method, the operation
must justify and document every item of expenditure and income anew. Brand-new
operations will utilize zero-based methods.
Zero Based
|
Year 1
|
Totals
|
|
Operating
exp.
|
|
Direct Labor and Benefits
|
391,765.00
|
Raw material Supplies-1
|
150,000.00
|
Raw material Supplies-2
|
150,000.00
|
Factory Waste
|
90,000.00
|
Maintenance/Parts
|
360,000.00
|
Fuel
|
28875
|
Cost of
goods sold
|
1,170,640.00
|
Administrative
Expenses
|
|
Rent
|
78,000.00
|
Utilities and phone
|
25,000.00
|
Office Expenses
|
60,000.00
|
Insurance
|
8,000.00
|
Other Operating Expenses
|
36,000.00
|
Total
office exp.
|
207,000.00
|
Advertising
and marketing Expenses
|
|
Advertising and marketing
|
50,000.00
|
Total
Expenses
|
257,000.00
|
The above mentioned example will help you to understand the
zero based budgeting. In this example it’s a new start-up company or a new
project, where we need to estimate all the expenses which may occur during the
operations.
In traditional budget, contrasting to Zero based, we know
what are our cost factors or revenue generator and how do they works. We
understand the business needs and requirements. Before analyst start working on
traditional budgeting he has to go through the current business plan,
management strategy related to expansion or contractions of the business,
government rules and regulation related to the industry, EXIM policy, stack
holders movement. These are some of the factor which affect revenue and cost model
to the company. Analyst can make an assumption based on his study and create a
model for next 5 years or more. While keeping this in the mind that if creating
model for longer term, it should be flexible enough to accept the future
changes.
Traditional
Budget
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
Operating exp.
|
||||
Direct
Labor and Benefits
|
658,098.08
|
749,523.12
|
820,886.49
|
916,985.54
|
yoy growth
|
14%
|
10%
|
12%
|
|
Raw
material
|
369,600.00
|
446,054.40
|
500,473.04
|
582,765.10
|
yoy growth
|
21%
|
12%
|
16%
|
|
Factory
Waste
|
221,760.00
|
267,632.64
|
300,283.82
|
349,659.06
|
yoy growth
|
21%
|
12%
|
16%
|
|
Maintenance/Parts
|
38,016.00
|
40,144.90
|
42,393.01
|
44,767.02
|
yoy growth
|
6%
|
6%
|
6%
|
|
Fuel
|
67365
|
76995
|
81810
|
90,215.53
|
yoy growth
|
14%
|
6%
|
10%
|
|
Cost of goods sold
|
$1,354,844
|
$1,580,351
|
$1,745,847
|
1,984,392.86
|
Administrative
Expenses
|
||||
Rent
|
80,340.00
|
83,540.00
|
86,046.20
|
89,050.53
|
yoy growth
|
4%
|
3%
|
3%
|
|
Utilities
and phone
|
51,500.00
|
54,540.00
|
56,176.20
|
58,676.86
|
yoy growth
|
6%
|
3%
|
4%
|
|
Office
Expenses
|
61,800.00
|
61,000.00
|
62,830.00
|
63,365.78
|
yoy growth
|
-1%
|
3%
|
1%
|
|
Insurance
|
37,080.00
|
40,100.00
|
41,303.00
|
43,604.52
|
yoy growth
|
8%
|
3%
|
6%
|
|
Other
Operating Expenses
|
61,800.00
|
65,800.00
|
67,774.00
|
70,983.94
|
yoy growth
|
6%
|
3%
|
5%
|
|
292,520.15
|
304,980.23
|
314,129.55
|
325,681.83
|
|
Advertising and
marketing Expenses
|
||||
Advertising and marketing
|
24,000.00
|
26,000.00
|
26,780.00
|
28,297.53
|
yoy growth
|
8%
|
3%
|
6%
|
|
23,999.48
|
26,000.08
|
26,780.03
|
28,297.59
|
|
Total Expenses
|
1,671,363.71
|
1,911,331.13
|
2,086,756.40
|
2,338,372.28
|
Historical record
|
Projections
|
YoY growth rate is the growth over the last year
(for historical data) and for projections it is the average of last 5 or more
year’s yoy growth rate.
Zero budget required thorough research to understand the
industry and its market as analyst need to start work on its foundation.
Analyst does not has any record and it is completely based on market research,
manager’s expectation and some assumptions. In contrast to it, traditional
budget analyst has all the past records but it does not mean that traditional
budget does not require market research. Analyst has to understand the current
market, new rules and regulation, IIP, cross border situation Etc.
Zero based budgeting and traditional budgeting are the main stream of budgeting. While analyst may increase the line to:-
Primary Budget:-
|
·
Capital
budget
|
|
·
Operating
budget
|
|
·
Cash budget/ Cash flow budget
|
|
·
Master Budget
|
Sub Budget:-
|
·
Sales
budget
|
|
·
Production Budget
|
|
·
Administration Budget
|
|
·
Manufacturing Overhead Budget
|
|
·
Project budget
|
|
·
Research and Development Budget
|
|
·
Marketing
budget
|
|
·
Direct labour budget
|
|
·
Direct cost budget
|
|
·
Compensation Budget
|
