Introduction
Budget is a monetary value allocated for different purposes. The budget is an inevitable portion of business operations because of several reasons. One reason is limited financial resources. This means that the company has to spend within its means so that it has to identify the areas requiring monetary resources and apportion the available resources according to priority and necessity. Another reason is accountability. Accountability pertains to the responsibility that the owners, managers and employees have in ensuring that the money apportioned is spent for the determined purpose. The foundation of accountability is the budget. (Weygandt, Kieso & Kimmel 2005, p. 971)
Benefits of Budget to a Business
A budget is a plan, a record and a forecast. It is a plan because it maps out the expected areas of spending together with the apportioned monetary resource. This serves as a guide to the limit of spending of the different operations of the company. It is a record or a printed document that businesses show to the government and to investors as proof of their monetary activities. The budget serves as a standard of performance. It is a forecast because it shows the pattern of future spending of the company. (Warren, Fess & Reeve 2005, p. 870)
The relevance of budget to the company enhances the importance of budgeting and budget management. Budgeting refers to the activity of matching the various planned actions and objectives with their respective estimated financial resource requirements. Budget management refers to the continuous process of drafting for approval a list of areas of spending and their corresponding monetary allocations based on a limited budget. This is followed by the activity of predicting price and cost as part of the spending plan. Then the next step is submitting the proposal and plan for approval. After approval, the implementation state involves supervision over performance through the identification and control of any occurring budget variances. (Weygandt, Kieso & Kimmel 2005, p. 972)
Parties Involved in the Determination of the Budget
The two elements of budget are income or money to spend and expenses or items subject of spending. The proper parties to determine the budget are the people with information about the income and spending of the company. (Weygandt, Kieso & Kimmel 2005, p. 1005) In small businesses, the owner or manager usually handles the budget but in larger businesses, there is a team of employees, in charge of finance management.
In the case of a family-owned cuisine restaurant, the finances and the budget of the business is handled by the owners themselves with tasks delegated to each family member. The spouses have two children and the delegation of tasks is cooking is done by the father with the assistance of the younger son, the cash register is manned by the wife, and waiting or food delivery is done by the older son together with two hired help. Thus, in the determination of the monthly budget, the father provides information on expenses on food ingredients, the mother knows the amount of money the business takes in everyday and the children provide information on other expenses in the maintenance of the restaurant’s physical structure. As the business grew and the restaurant is nearing its full capacity, the family hired two more people to help in the kitchen and in delivery and hired three more as the children moved out of state to earn a college degree. The business was a success that the owners searched for another location to establish a branch. The branch had a manager and six employees. In doing the budget, the parties involved included the spouses and the manager. Although the budget was done separately for the two restaurants, the spouses had to know the financial performance of both to determine their ability to pay for the amount loaned to start the restaurant branch. The goal is to make the restaurants independent with the revenue received by each restaurant covering its respective expenses.
Methods/Steps in Arriving at a Budget
There are two basic types of budget. One is cash budget that provides an estimate of the cash position of the business in a given period. Cash budget involves the consideration of the liabilities of the business and schedules the payment of these liabilities according to the schedule of the receipt of revenue from by the business. Cash budget starts with a list of the starting cash balance followed by expected revenue for the period covered by the budget added to the starting cash and then followed by the expenses such as liabilities deducted from the total cash balance. The positive remaining amount determines the cash earned by the business. (Weygandt, Kieso & Kimmel 2005, p. 978; Minbiole 2000, p. 225)
Another is operating budget that serves to forecast the revenues and expenditures for a year or less. This involves the listing of income and expenses into two columns, with every source of income and areas of spending itemized to compare the difference in total income and total expenditures. This method is helpful in mapping the revenue generation and spending of every area and stage of the business. Using this method enables the owners/managers to determine and evaluate the financial soundness of the business. (Young 2003, p. 191; Minbiole 2000, p. 212)
In the case of the cuisine restaurant, the initial budget method used was a simple cash budget where the family totals the sales revenue and expenses for food ingredients, salaries and other restaurant expenses and determines the difference in amount between the two items. The remaining positive amount becomes the earnings of the family. The starting capital was family earnings so they also considered earning back the amount they spent in starting the business. However, as the business grew and another branch was set-up, the items considered in the budget increased because of the loan, monthly rent, added salaries of workers, and other expenses. The family shifted to the more elaborate operating budget that covers an entire year of business operations. Change was needed so that the owners can foresee incoming and outgoing cash flow in the next twelve months and assess the ability of the company to meet its scheduled debt payments and obligations to employees.
Evaluating the Budget Method
There are four elements to be considered in evaluating the budget. First is the purpose of the budget (Warren, Fess & Reeve 2005, p. 870; Oliver 2000, p. 13). The budget may be for the purpose of planning or scheduling the payment of debt or forecast the future financial performance of the business. Depending upon the purpose, the focus of the budget would also differ. If the purpose were to map-out debt payment, the focus would be on the itemization and spread of the amount to be paid every month based on the expected revenue of the business. If the purpose of the budget is to forecast financial performance, then the focus is on the remaining amount after expenses are deducted from the income.
Second is the complete listing of all sources of income and areas of expenditure (Warren, Fess & Reeve 2005, p. 870). This is important because the reliability of the budget depends upon the inclusion of all expected income and expenses. In the operating budget, the items to be included may be the sales revenue, production revenue, total labour cost, operating expenses, and capital expenses. If even a single item regardless of how small is omitted from the budget, the mapping of liability payments and forecasting will be affected.
Third is accurate estimation of amounts based on previous financial performance by using income statements, balance sheets and other relevant finance documents (Jiambalvo 2000, p. 355; Minbiole 2000; p. 239). Accuracy is important because this adds reliability to the budget especially if the budget serves as a guide to the limit of spending of the company. Ideally, a business should not spend beyond its means and the means of a company is stated in the budget. An inaccurate budget would cause negative effects to the business.
Fourth is flexibility to variances (Jiambalvo 1994, p. 357; Minbiole 2000; p. 239). Although, the budget is a mere estimate, it should be accurate enough to be reliable but flexible enough to cover any changes in the financial performance of the company due to both internal and external forces. The budget should consider every possible expense that the company may incur in the period covered by the budget because it is better to incur expenses less than the amount stated in the budget than to overspend.
In the case of the budget of the cuisine restaurant, the cash budget method initially used by the owners was not completely effective because there were always one or two expense items incurred during the budget period not included in the original budget. There was a tendency to spend beyond the budget due to the failure to anticipate all expected business expenses. At the start of the business, there were no previous financial records from which to base the budget so the owners had problems with the income and expense itemization. Since the business is family owned there is also the tendency to mix business and personal expenses so that the budget was not as accurate as it should be. The purpose of the cash budget was to see whether the business is earning so the owners are content as long as there is a consistent positive amount remaining after expenses are deducted.
However, after the owners gained experience on the operations of a restaurant business, they were able to lessen incurring unplanned expenses. The expansion of the business through a branch meant that the owners had to develop a more itemized and accurate budget. The increasing income and expense items required the more elaborate operating budget method especially since the purpose of the owners now is to determine the schedule of liability payments and other expenses relative to the in flow of cash. Since the owners have gained experience in the restaurant business, the number of unplanned expenses was minimized resulting to a more accurate budget. Estimations in the budget were also based on the previous financial records of the business.
Apart from the contents of the business, budget evaluation may also be made by considering how effective the budget is based on the appropriate budget approach. Top down, bottom up and zero-based budgeting constitute the three budget approaches. A top down budget approach means that the budget is prepared by the owners or top managers of the business and imposed downwards to the rest of the organization. Top down budget reflects the goals of the owner/managers. This works for small businesses but subject to limitations in large firms. Bottom up budget are prepared by supervisors or middle managers and then submit them upwards to the owners or top managers for approval. This is ideal for large businesses because middle managers are most qualified to provide information on the income and expenses of the different areas of operation. (Oliver 2000, p. 49) Zero-based budgeting works through every manager providing an estimate of the proposed expenses in her area of responsibility as if doing so for the first time. Since managers are required to start from scratch, they should be able to justify their proposed budget. (Jiambalvo 2004, p. 343)
In the cuisine business, the budget approach is top down. The approach is relevant to the business because its operation is small and the owners and the manager of the branch has a clear view of all aspects of operations covering income generation and expenditures so they are able to make an accurate and reliable budget.
Reflection on Budget
The budget is inevitable to any business because it reflects the operations and financial performance of the business in the past, at present and in the future. The budget is important to assess the continuity of the business and to ensure that the business is able to meet its liabilities to creditors and obligations to the people who work to earn income bigger than the expenses of the company.
References
Jiambalvo, J 2004, Managerial Accounting, John Wiley & Sons, New Jersey.
Minbiole, EA 2000, Accounting Principles II (Cliffs Quick Review), IDG Books Worldwide, Inc. California.
Oliver, L 2000, The Cost Management Toolbox: A Manager’s Guide to Controlling Costs and Boosting Profits, AMA Publications, New York.
Warren, CS, Fess, PE & Reeve, JM 2005, Accounting, Thompson Corporation, Ohio.
Weygandt, JJ, Kieso, DE & Kimmel, PD 2005, Accounting Principles, 7th edn, John Wiley & Sons, New Jersey.
Young, D 2003, Techniques of Management Accounting, McGraw-Hill, New York.
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