What is Budget?
A budget is a monetary and quantitative expression of business plans and policies, prepared in advance, to be pursued in the future period of time.
According to certified Institute of management Accountants, Budget is defined as “A budget is a financial and or quantitative statement prepared prior to a defined of time, of the policy to be pursued during that period for the purpose of attaining the objective.”
Characteristics of a Budget
The main characteristics of a budget are:
- A comprehensive business plan showing what the enterprise wants to achieve.
- Prepared in advance
- For a definite period of time
- Expressed in quantitative form, physical or monetary terms, or both
- For achieving a given objective
- A proper system of accounting is essential
- System of proper fixation of authority and responsibility has to be in place.
Classification of Budgets
Budgets can be classified on the basis of time, function and flexibility.
Classification on the basis of time
Classification on the basis of function
Classification on the basis of flexibility
1. Classification on the basis of time
Budgets can be long-term and short-term. Long term budgets relate to a period ranging from 5 to 10 years. Only the top level knows these budgets and lower level would not be aware of.
These budgets are prepared for certain areas of the enterprise such as capital expenditure and research and development. Short-term budgets are for one or two years.
2. Classification on the basis of function
Budgets are divided on the basis of different functions performed in the organization. They are sales budget, production budget, purchase Budget, Direct labour Budget, Overheads Budget, cash budget and finally master budget.
The master or final budget is a summary budget, which incorporates all functional budgets in a summarized form.
3. Classification on the basis of flexibility
There are two types of budgets on the basis of flexibility.
- Fixed Budgets
- Flexible Budgets
The budget is prepared on the basis of fixed level of activity. In other words, a fixed budget remains unchanged irrespective of the change in volume or level of activity. It is presumed that the forecast and the actual level of activity, both production and sales, would be one and the same.
Flexible budget is a good budgeting technique as well as tool of control. Flexible budgets are prepared where the level of activity cannot be estimated with accuracy.
A flexible budget recognizes the difference between fixed, semi-fixed and variable cost and is designed to change in relation to the change in level of activity.
The flexible budgets will be useful where the level of activity changes and cannot be estimated at the time of preparation of budget.
This type of budget is prepared for a range of production activity say 15,000 to 25,000 units.
Compensating Balances – Steps in Preparation of flexible Budget
Decide the range of activity (say 15,000 to 25,000 units) to which the budget is to be prepared.
Decide the behavior of each element of cost, which are included in the budget, into fixed, semi-fixed and variable cost.
Select the activity levels (say 15,000, 18,000, 20,000, 22,000 and 25,000 units) in terms of production.
Prepare the budget for each level of authority by associating the corresponding cost with each level of activity.
Budget is a systematic plan for utilization of manpower and other resources. It acts as a barometer of a business as it measures the success from time to time, against the standard set for achievement.
To achieve the anticipated targets, planning, co-ordination and control are the important main tasks of management, achieved through budgeting and budgetary control.