Importance and classification of budgets

Importance and classification of budgets

Budgets are not only a model for financial projections of income, balance sheet and resource flows with indicators; but also as a set of activities that are based primarily on the strategic level and to a lesser extent in the operational level.

Due to the great problems of coordination and monitoring of the performance, large companies are likely to have a more detailed budget. Today, many companies have created corporate financial models that enable the administration to plan powerful testing results of various strategies and activities.

The purpose of a budget is to plan for the future of the organization in terms of money and volumes, managing income and expense of the company, to coordinate and relate the activities of the organization and achieve the results of periodic operations. Budget can be conceptualized as the planning tool and predetermination of figures based on forecasts of facts and random phenomena, as a result of conditions under which you are operating a business during a given period, ensuring that these conditions are met.

A budget is one that is based on the integration and implementation of expenses and revenues that are expected to arise in the future when compared to previous one.

Classification of budgets

When it comes to classification of budgets, different authors have expressed various points of view on the subject. So there is no uniform standard to classify budget. In general they can be classified as follows:

  • In terms of the figures that are budgeted
  • In terms of their execution time
  • In regard to the possibilities of modification
  • In terms of the type of entities that will be used

Classification of budgets in terms of the figures that are budgeted

a) Operating Budget: To establish which are the operations or activities that are going to develop in the future and their financial impact. The operating budget is further divided into sales budget, production, purchasing, inventory, labor, manufacturing costs, selling expenses, administrative expenses, other expenses, net of tax, collective investment accounts.

b) Financial Budget: It is the summary of operating budgets, which are reflected in the financial statements.

c) Capital budgeting: a list of potential investments or acquisitions of fixed assets, which should be considered as a draft for evaluation.

Classification of budgets in terms of execution time

a) Short Term: Those planning the administration during the normal business cycle of the organization, which in general terms is 12 months.

b) Medium Term: They assess or project investment results that generally range from three to five years. They may not give sufficient information on the management of the company.

c) Long Term: Refers to large-scale projects or investors who definitely could not be boxed as short term or medium term, fluctuating in a period that is usually more than five years, in order to evaluate and monitor company’s investments.

Classification of budgets in regard to the possibilities of modification:

a) Rigid: those that are not possible to change, taking that as a disadvantage, we can use that as efficient control parameters.

b) Flexible: Refers to plans as a result of developments in the operations of the company, which may be tailored to their actual needs, offering flexibility to changes or modifications.

Classification of budgets in terms of type of entities that will be used:

a) Public: Those who are used as a measure for planning and control of public management.

b) Private: Those to whom it is intended to hold the business management, which are elaborated from the utilities and were subsequently determined by other concepts.

Planning is often the difference between success and failure for a business. Fostering early thinking in a coordinated way, the budget process is a useful management tool for all phases of business operations. Managing budgets not only helps to anticipate problems ahead, but also serve as performance standards for the progress of the business.

There is no set formula as to the shape, detail or periods covered by the budget. Each budget system should be designed according to the demand and situation. Usually, the budget system will picture more detailed aspects of the operations that are more important to the company. In addition, the period covered by the budget will vary according to the nature of the plans involved and the possible degree of accuracy in the preparation of estimates.

Budget should focus on long-term planning, which is important for the success of any business organization. The ability to forecast sales is crucial in the effort to determine the future financial needs. As sales increase, more investment in assets to support this should also increase. This increase in assets should be financed with some combination of funds in the short and long term.

The culmination of the budget formulation process is the preparation of a pro forma balance sheet, which represents the position of the company at some point in the future. The analysis of this pro forma income statement should reveal whether the plans presented in these statements will guide the company through the desired path by the administration.

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