What does 'Budget' mean
A budget is an estimation of the revenue and expenses over a specified future period of time and is compiled and re-evaluated on a periodic basis. A surplus budget means profits are anticipated, while a balanced budget means that revenues are expected to equal expenses. A deficit budget means expenses will exceed revenues.
BREAKING DOWN 'Budget'
A budget can be made for a person, a family, a group of people, a business, a government, a country, a multinational organization or just about anything else that makes and spends money. A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged for another. A budget is an internal tool used by management and is often not required for reporting by external parties.
Hierarchy of Budgets
The sales budget is often the first to be developed in a business as subsequent expense budgets cannot be established without knowing the future inflows. Budgets are developed for different divisions, subsidiaries and departments within an organization. For a manufacturing organization, a budget is developed for direct materials, labor and manufacturing overhead.
All budgets roll up into the master budget that encompasses all smaller budgets. The master budget also includes budgeted financial statements, forecasts of cash inflows and outflows, and an overall financing plan.
Budget Development Process
The budget process begins by establishing assumptions for the upcoming budget period. These assumptions are related to projected sales trends, cost trends and overall economic outlook of the market. Specific factors affecting potential expenses are addressed and monitored. The budget is published in a packet that outlines the standards and procedures used to develop the financial tool. The procedures include the assumptions of the markets, key relationships with vendors that provide discounts and how certain calculations were made. Upon the completion of all budgets, top management reviews the budget and submits the budget for approval to the board of directors.
Static Vs. Flexible Budgets
There are two major types of budgets: static budgets and flexible budgets. A static budget remains unchanged over the life of the budget. Regarding of changes that occur during the budgeting period, all accounts and figures remain the same as the figures were originally calculated.
Alternatively, a flexible budget has a relational value to certain variables. The dollar amounts listed on a flexible budget change based on sales levels, production levels or other external economic variables.
Both budgets are useful to management. A static budget evaluates the effectiveness of the original budgeting process, while a flexible budget provides deeper insight into business operations.