Budgeting is crucial for decision-making. It gives a business a sense of direction. A budget is an anticipated computation of revenues and the ways in which those revenues will be spent in achieving the business’ goals.
Budgeting involves planning for the future. The ideal is to plan in advance for the next five years through the development and implementation of a strategic plan. Control is an important part of the budgeting process because it assesses what actually happens against what an organization has planned.
If ABC, Ltd plans to enter the market with a new product, the budget process anticipates the number of units that should be available for sale to fulfill the market needs for that specific product after taking into consideration other factors such as competition share and marketing strategies to promote and position that new product. It should also consider the direct labor, direct material, indirect costs, and overhead related to the production of such product. The sales budget becomes the plan action needed for ABC, Ltd to achieve the expected 5% of the market share.
Organizations that keep a sound budgeting system prepare a master budget, which is the comprehensive financial plan for the organization as a whole. According to the company’s needs it should to be broken down into quarterly or monthly budgets. The reason is that management can monitor the budget performance by evaluating actual against budgeted amounts and taken corrective measures when discrepancies are noted.
Components of the Master Budget
Two major components are: operating and financial budgets. While the operating budget provides the income generating of an organization, the financial budget anticipates the inflows and outflows of cash and the overall financial position.
A budgeted income statement includes schedules as follows:
- Sales budget
- Production budget
- Direct material purchases budget
- Direct labor budget
- Overhead budget
- Selling and administrative expenses budget
- Ending finished goods inventory budget
- Cost of goods sold budget.