Content, order and logic of this chapter
Within this chapter we will cover the following topics:
- What does budgeting mean?
- Forecasting methods
- Why budget?
- Methods of budgeting
- Budget culture
Order and logic
You need to know what people are talking about; the words forecasting and budgeting are used and (mis)understood in many ways. Budgeting is a key, if not the key, element of strategic planning and delivery.
The importance of budgeting and the classification of budgets will depend on factors such as the industry sector, size of company, stage of development of the company and the level at which the budget is to be operative. Techniques that can assist in forecasting are considered, followed by review of the different approaches to budget preparation.
This leads into the minefield of culture. This is a good topic to leave until last, as a budgeting process ultimately will succeed or fail depending on whether there is an appropriate culture which has an aligned process and reporting system.
What does budgeting mean?
Let us be clear from the outset as to why a budget is needed: is it merely what one does? The word 'budgeting' may be used in many contexts. For example, there is budgeting of sales or output, costs, profit, resources, cash and capital expenditure. The reasons for budgeting, forecasting or anticipating figures are many, the most obvious being as a means of measuring performance and thus controlling a business. This chapter deals with budgeting sales, costs and thus profit (or loss!) - the budgeted P&L account anticipated for the future, or what is termed the 'operating budget'.
The word can mean many things to the business person and many to the accountant. At its most basic, or primitive, budgeting is the exercise of living within your means. There is a certain, probably fixed, amount of income, and costs should not exceed this. The concept of prudent budgeting and living was summed up succinctly by Mr Micawber in Dickens' David Copperfield: 'Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.'
Cash budgeting is the simplest form of budgeting but it demonstrates the principle of the need to forecast when amounts of events are likely to happen, in this case cash flows in and out. Operating budgets are an accrued version, that is, they record when the event of a sale or a cost is forecast or expected to occur. The distinction between 'forecast' and 'budget' is explored below.