Importance of Budgeting in Business | FlyingColour
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Importance of Budgeting in Business

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Overview:

Importance of budgeting in business is not limited to estimation of planned sales volumes and revenues; resource quantities, costs and expenses; assets, liabilities and cash flows over a specific time period which needs to be compiled and re-evaluated on a periodic basis based on the needs of the organization. These targets include both the overall business targets as well as the specific targets for the individual units within the business.

Reasons for budgeting in business

  • A medium through which future expectations for a period is communicated throughout the organization.
  • Helps in planning the occurrence of cost and expenses in advance so that unnecessary expenses could be minimized.
  • Motivates employees to attain goals along with improving decision making.
  • Reveals upcoming “Opportunities and Threats” for the business.
  • Rapid communication of expected performance from business units.

Why budget is important for any organization?

There are several key steps you should follow to make sure your budgets and plans are as Effective, realistic and useful as possible.

  • Invest some time for planning and creating the budget:Investing some time will give definite return over time. If you invest some time in creating a comprehensive and realistic budget, it will be easier to manage and ultimately more effective.
  • Use previous year’s figures: Collect historical information on sales and costs – these could give you appropriate indication of likely sales, costs& specific controllable costs. However it requires consideration as to what your revenue plans are, how your revenue resources should be used and any changes in the competitive environment.
  • Create realistic budgets:Expected Revenue and future reduction in cost for period should be determined keeping in mind all internal and external factors in the light of resources available to the entity making it achievable through efforts. Setting a budget at higher end will demotivate the employees.
    It’s useful for your sales forecast to project variable costs and use to work out the relationship between variable costs and sales. For example, if your unit costs reduce by 10 per cent for each additional 20 per cent of sales, how much will your unit costs decrease if you have a 33 per cent rise in sales?
    Make sure your budgets contain all the relevant information for you to easily take monitor the key factors of your entity such as revenue, cost and working capital. Business accounting software could help you manage your overall accounts.
  • Involve the expert & finance staff:It’s better to consult executive / experts with financial responsibilities to provide you with estimates of figures for your budget – for example, revenue targets, variable cost or specific project costs. This would help in the preparation of more realistic budget.

What your budget should cover?

Decide how many budgets you really need. Small businesses can prepare a comprehensive operating budget which sets out how much money is needed to run the business over the coming period – usually covering the period of a year. As your business grows, your total operating budget is likely to be segregated in several individual budgets such as your sales budgets, production, cash or marketing budget.

  • Projected cash flow – Your cash budget projects your future cash position. Budgeting in this way is vital as it can pinpoint any difficulties you might face in the period. It should be reviewed at least quarterly.
  • Costs – Commonly, your business has three kinds of costs:
  • Fixed costs – items such as rent, salaries and financing costs.
  • Variable costs – including raw materials, direct labour.
  • One-off capital costs – Investment in Assets and infrastructure.
  • Revenues – Sales or revenue forecasts are typically based on an analysis of historical data and setting the expected revenues while considering changes in the environment.

Using your revenue and expenditure forecasts, you can prepare projected statements of profit & loss for the next 6 or 12 months depending on the business model. This will help you to analyse your margins and other key ratios such as return on investment (ROI), Variances etc.

For better execution budget must be prepared keeping several points in mind. Some of the Prerequisites of Effective Budget are mentioned as below –

  • A serious attitude to the system is required.
  • Clear demarcation between areas of managerial responsibility.
  • Reasonable budget targets.
  • Established data collection, analysis and reporting techniques.
  • Reports aimed at individual managers, rather than general.
  • Fairly short reporting periods, typically a month.
  • Timely variance reports.

Formulation of a budget usually requires a continuous watch on actual result compared with budgeted figures under the supervision of a Senior Executive; he must be assisted in this work by a Budget Committee, consisting of all the heads of the department along with the Managing Director as the Chairman. A Feedback system is usually used in assisting Budget setting. With the existence of feedback system i.e. inviting feedback from the operational level of people in an organization makes the budget more effective and reactive to the changes in the environment. It also aids top management to take prompt decision. The Controller is responsible for coordinating and development of budget programs and preparing the manual of instruction, i.e. Budget manual.

This blog post written by Mr. Taher (CA), Tax advisor at Flyingcolour Business Setup, Accounting & Tax Services in Dubai and UAE, emphasize in providing the best advisory and customer satisfaction to clients. Please send inquiry to info[at]flyingcolour[dot]com or call +971 4 4542366.

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