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Business Fundamentals was developed by the Global Text Project, which is working to create open-content electronictextbooks that are freely available on the website http://globaltext.terry.uga.edu. Distribution is also possible viapaper, CD, DVD, and via this collaboration, through Connexions. The goal is to make textbooks available to the manywho cannot afford them. For more information on getting involved with the Global Text Project or Connexions email us atdrexel@uga.edu and dcwill@cnx.org.

Editor: Donald J McCubbrey (Daniels College of Business, University of Denver, USA)

Reviewer: Roger K Baer (CPA, LLC; and Former Partner, Arthur Andersen&Co., USA)

Budgets

Earlier, we discussed cash flow forecasts and how they are used. An extension of the cash flow forecast concept is the operating budget. Most organizations have them. A budget is the financial expression of an organization’s operating plan for a period of time, usually at least a year. Prior to the beginning of the year, managers prepare a plan for what they hope to accomplish in the coming year in terms of revenue, expenses, and net profit. 

A more formal definition of a budget is:

“A budget is a financial document used to project future income and expenses. The budgeting process may be carried out by individuals or by companies to estimate whether the person/company can continue to operate with its projected income and expenses.
A budget may be prepared simply using paper and pencil, or on computer using a spreadsheet program like Excel, or with a financial application like Quicken or QuickBooks.
  • The process for preparing a monthly budget includes:
  • Listing of all sources of monthly income
  • Listing of all required, fixed expenses, like rent/mortgage, utilities, phone
  • Listing of other possible and variable expenses”. (Biztaxlaw.about.com 2009)

Then, as the year unfolds, actual income and expenses are posted to the accounting records, and compared to what was budgeted, and a variance from budget for each item budgeted (e.g. sales, selling expenses, advertising costs, etc) is calculated. Managers responsible for the various income and expense items then examine each variance and, if it is substantial, search for an explanation. For example, it is one thing if electricity costs are 20 per cent higher than what was budgeted for one month because workmen were using power tools to repair the roof. In that case, we can expect costs to return to normal when the repair work is completed.  It is quite another thing if costs are higher because the electric company raised its rates. In that case, we can expect that costs will be at least 20 per cent higher in the future.

Forecasts

Most organizations take budget variance to date into consideration each month, and then prepare a revised budget (or forecast ) for the balance of the year. This step is particularly important if variances to date vary from the original budget in a major way. For example, if sales are less than projected because market conditions are less favorable than anticipated when the budget was prepared, managers may look for ways to increase sales or reduce expenses in order to avoid a loss for the year.

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Source:  OpenStax, Business fundamentals. OpenStax CNX. Oct 08, 2010 Download for free at http://cnx.org/content/col11227/1.4
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