Budgeting: Ensuring your company's financial health | SMB World Asia

By Melba Bernad | May 30, 2012

Budgets are incredibly important for small and medium-sized businesses; they are supposed to help keep spending under control and ensure financial health. Allocating budgets for departments or business activities requires thorough planning otherwise one small miscalculation could spell financial disaster.?

Annual budgeting and monthly budget reviews should be a part of every business? management process.

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An IBM whitepaper on ?Best-Practice Budgeting? notes that budgeting is not popular in many organizations because managers see the process as a time-consuming and recurring setup for executive blame and recrimination over negative outcomes that they could neither predict nor control.

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However, despite challenges and issues, virtually no business forsakes the budgeting cycle. There is too much risk in the end result to run a business without a financial plan.

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John A. Tracy, a professor of accounting and author of several finance books, says that budgeting forces managers to do better forecasting. It also motivates managers and employees by providing useful yardsticks for evaluating performance. Budgeting can also assist in the communication between different levels of management.

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Budget Types

There are several types of budgets, but the more common types are the operating budget, capital expenditures budget, and financial budget.

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The operating budget is the budget for income statement elements such as revenues and expenses.?

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The capital expenditure budget is the budget for expected investments in capital assets and long-term projects.

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Meanwhile, the financial budget deals with the expected assets, liabilities, and stockholders? equity.

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Determining how much money should go to each budget depends on the business? priorities and goals. To best serve the company?s long term goals and objectives, develop a budget that is in sync with the company?s corporate strategy.

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Budgeting Methods

But how do you come up with a budget for each? There are three key methods to developing a budget: top down, bottom up, and zero-based budgeting.

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With the top down approach, estimates for expenses originate at the top of the organization and imposed on the lower layers of the organization.

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According to finance experts, this method can be unrealistic because upper management may not have enough knowledge about the individual departments to come up with a budget.

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The more realistic method is the bottom up approach. Department managers create budgets for their department and then send them up the chain of command, so that all of the individual proposals come together to form the entire business budget.

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While the bottom up method can be more accurate, department or project managers may end up asking for more funding than will actually be needed.

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Under the zero-based budgeting method, each manager creates a budget from scratch? not based on historical data. This approach is complex and time-consuming since individuals and managers in each department must create a detailed budget specific to the next budgeting period.

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Budgets are only useful tools as long as they are followed and used to make necessary adjustments. A good budget should be flexible such that it can incorporate changes in the future. However, if a budget is created and then ignored, it can't help a business manage finances.

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While creating your budget you need to decide if you will be creating a monthly budget or even a yearly budget. These days, the budget may be out-of-date as soon as it?s approved.

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Finally, your current financial situation will strongly dictate how you will allocate funds. Limited cash inflow means that you need to slash the budgets proposed. Massive cash flow, on the other hand, means a lot of money at your disposal.

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