How to Create a Budget in 6 Simple Steps

Question 1 

In general, budgeting involves a process of creating a plan on how to utilize personal or business money. The budget is a spending plan. It is this plan that allows an individual or a company to determine in advance whether the money available is enough to fund the current operations or activities. More often, in cases where there are insufficient funds, the budget is normally used to prioritize spending and focus them on the activities that are of more importance. In other words, budgeting acting as a balancing between expenses and income. Therefore, if these two elements don’t balance it is either the company has spent more than it was planned or the actual income was excess of the plans. However, since the major aim of the budget is to develop a spending plan for the money, it ensures that you have money for the expenses you have created. In many cases, a spending plan helps the entities keep out of unnecessary debt.

Budgeting variance act like a “like” in spending plans of an entity which are either favorable or unfavorable. The basic causes of variance can either result from the changes in quantities or prices. For instance, take that Target Corp reported regard of maintaining prices they managed to sell more products. In such a situation, there is a favorable variance in improved sales which resulted from an increase in the quantity sold. This may also apply in manufacturing where the material costs increases. This becomes an unfavorable variance since the changes advance the expenses. It is always important for the management to perform a budget variance analysis. This process involves determining and investigating the possible causes of variance. In other words, it is “digging” as to “why” which demonstrates the weakness or strength of the company. With this process, it is important to consider whether the variance is a short or long-term problem. Therefore, if it is expected that this will continue, there is a need for a permanent solution. If the variance problem is as a result of inefficiencies of the entity’s process, the expected results would be such as increased manufacturing cost.

The budget variances require an immediate corrective action as soon as they have been detected. For instance, if the sales for Target Corp are increasing, the company might spend more on advertising to seize on the unexpected popularity. Serious solutions are required for unfavorable variances. In cases where inefficiencies have been detected, the managers find out the means of improving. For instance, they may substitute with cheap raw materials, improve the conditions of the machines by replacing obsolete equipment.

Question 2 

Zero-based budgeting (ZBB) involves developing a budget from “scratch” without reference to the previous year’s spending numbers or budget. With this budget, there are no activities assumed to be “untouchable” and thus, all expenses indicated in the budget are justifiable. Further, if the company decide to use ZBB, it must set completely new spending goals. For instance, Target Corp uses the budget to accomplish its financial goal and curve spending. However, they are based on the previous year’s spending figures. The manager is first required to identify the task and assess ways and means of accomplishing the task. This is followed by evaluating the possible solutions and evaluating alternative of sources of funds. The last step is to set the budgeted priorities and numbers. This provides the manager with a comparison tool or benchmark to set spending goals. Further, the aim is to locate where the costs can be cut to reduce expenses.

ZBB has a number of pros and cons. First, accuracy is the major advantage of ZBB. Unlike other types of budget, this computes the operation costs after relooking each and every item of the cash flows from each department. To some extent, this is considered to help reduce costs as it brings out a clear analysis of the costs against the desired performance. Second, the efficiency of the ZBB as it helps in allocating resources efficiently. This is because it uses the actual numbers rather than historical numbers. Last but not limited to is a reduction in redundant activities. ZBB helps in identifying opportunities and other cost-effective ways of getting rid of redundant and unproductive activities.

On the disadvantages, ZBB is time-consuming as it involves intensive exercises for an entity. Further, it is carried out every year as against incremental budgeting. In addition, it requires high manpower as it is made from scratch and requires the involvement of various departments and a large number of employees. In conclusion, the aim of the ZBB is to reflect the true expenses as incurred by various cost centers within the company. Although this type of budget consumes a lot of time, it provides more accurate numbers compared to the incremental method budgeting. At the end of the day, it depends on the company's management decision on the appropriate budgeting method that fits their operations.

Question Three 

In today’s business world, the businesses can only run smoothly and better if their budgets reflect the strategic goals. However, managers need to have a specific guideline on how to achieve these goals. Further, businesses should be in a position to manage their own resources in order to be able to respond positively to the unforeseen challenges. Though, this is only possible the budget aligns with the business strategies who are their impact on operations are known. With this, the manager is in a knowhow of which and where to locate resources.

The process of budget preparation may either be based on the manger’s personal decision or market conditions. Although both guiding factors focus on a common goal of allocating funds effectively, they may differ in terms of impact to the business. First, since managers do not have a broad comparison of goals with the market, they may set unrealistic goals. It is fact that the most basic decisions in a business are goal setting. Managers may anticipate goals that cannot be attained by the company considering the resources limitation. The proof factor of any budget is positioning your company to that of competitors. This is only possible the decision to make budgets are based on market factors rather than personal decisions from the mangers.

It is a fact that for a company that is pursuing manager’s personal goals that are unattainable my end up incurring more losses. The setting of the budget may expensive. However, the most expensive would be paying for unattainable goals. For instance, Target Corp’s manager may anticipate that sales are likely to increase let say with 50 percent in a certain period in the future. Without any justifiable reason behind this decision, the manager may decide to increase the level of production. If the anticipated sales fail to increase by 50 percent, the company will have “stagnating” or idle stock. Further, due to the presence of variable costs, the increasing volume of products produced in increases the overall cost of production. While offsetting these cost in the income statement, it decreases the gross profit of the company. With the idle stock in the store, the company only decide to sell at a “throw away” prices to reduce the risk of damage. In short, the lack of proper budget planning or making budget decisions based on the personal decisions of the manager may result in financial losses and unnecessary funding.

References

Gachoka, N., Aduda, J., Kaijage, E., & Okiro, K. (2018). The Moderating Effect of Organizational Characteristics on the Relationship Between Budgeting Process and Performance of Churches in Kenya.  Journal of Finance and Investment Analysis ,  7 (2), 1-5. 

Miller-Nobles, T. L., Mattison, B., & Matsumura, E. M. (2016).  Horngren's Financial & Managerial Accounting: The Managerial Chapters . Pearson.