A budget is a financial plan for a specified period (Shim, 2011) . The period of its preparation depends on an organization ’s policy, but a typical budget is planned for one year. The types of budgets include a sales budget, capital budget, project budget, and cash flow budget. Budgets are an important part of planning process.
Importance of Budgeting in the planning process
Offering the roadmap
The budget sets out clear financial goals by defining them at the beginning of the process. Planning determines the resources it would utilize in the whole process. Nevertheless, it relies on budgeting, to measure if the requirement will be realizable or not. Budgeting gives it a go-ahead if it can cover the costs, and approve additional sources of funding.
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Coordination of plans
Budgeting brings together all the company’s plans by integrating them into a total plan along with a budget. Any plan in an organization for production must involve budgeting to ensure that it is successful. In case one section has a plan of production, they require a budget, which will enable them to know the requirements to be sourced from another department in the same firm. This unit will set out a plan, to meet needs of the first division.
Controlling the plans
The planning process involves utilization of resources, but not generation. The inclusion of the budget helps in controlling the planning process. A budget prevents the initial plans from changing into a new idea as it strictly allocates the scarce resources. The managers will work on the initial plans while watching if it deviates from the set plan. Any changes in plans will be shown in the budgets as a variance. In the end, a budget acts as a watchful tool.
Motivation
A budget motivates managers and workers who participate in the planning process (Sanoff, 2016) . This motivation is by striving to adhere to the set budget than moving away from it. The managers and workers realize that sticking to the budget helps in coordinating the overall plan. Coordination of the plans leads to achieving the firm’s ultimate goal. However, if the planning process was imperfect, it will not stick to the budget thereby leading to demoralization.
Differences between operating and capital budgets
One of the differences between capital and operating budgets is the purpose of preparation. The capital budget preparation is for evaluation of investments or expenditure, which are long-term. Conversely, the preparation of operating budgets is to track recurrent revenues and expenses incurred by the company.
Secondly, their difference lies on the budget planning periods. The period of the capital budgets is several years. This extensive period is because it deals with long-term projects. The operating budget period is shorter than for capital budget. Its preparation is usually quarterly some monthly, semi-annually, or annually.
Continually, the purpose of preparation of the capital budget by a firm is to increase its valuation in the end. Acquisition of capital investments expands the value of the company because of the additions of the fixed assets. On the other hand, the preparation of the operating budget is to help the business to cut its operational costs apart from only tracking the expenditures.
In capital budgeting, since it deals with fixed assets depreciation is required during its preparation. The operation budget does not need calculation of depreciation because its contents are recurrent expenditures and not capital expenditures. Moreover, Capital budgeting in its calculation considers the time value of money (Sinclair, 2010) .
The other difference between the capital budget and operation budget is that the former does not affect cash flows. It mostly relies on debt for funding.
Reference
Sanoff, H. (2016). Integrating Programming, Evaluation and Participation in Design (Routledge Revivals): A Theory Z Approach . Abingdon-on-Thames: Routledge.
Shim, J. K. (2011). Budgeting basics and beyond (Vol. 574). Hoboken, New Jersey: John Wiley & Sons.
Sinclair, D. R. (2010). Capital budgeting decisions using the discounted cash flow method. Canadian Journal of Anesthesia/Journal canadien d'anesthésie, 57(7) , 704-705.
