Budget : Explanation, Types and its Classification

In our day-to-day life, we make various plans like purchasing a new car, house, and other necessary things. Have you ever wonder that how to make these plans successful? Either you can fully depend upon your luck and hard work or can make a good budget.

To learn the concept of budget from the root, it's very important to have a deep understanding of some important terms.

Define Budget

A budget is a business plan in numbers or a budget is an estimation of revenue and expenses over a specified period of time and it's utilized by business, government, and individuals. 

Revenue is the amount of business earned by selling its products or providing services to customers. The usual items of revenue are rent received, interest received, dividends, and many others.

Expense is the cost incurred by a business in the process of earning revenue. The usual items of expense are rent, wages, salaries, internet, and many others.

Example of Budget - How much a company is planning to spend on an upcoming new project.

Define Budgeting

Budgeting is the process of creating a plan to spend your money. This spending plan is known as a budget. The business plan and budget should sit side by side, how much will it cost and how much business will make.

Define Forecasting

Forecasting is the prediction of upcoming events or trends in the business on the basis of past and present data.

Types of Budget

There are 3 types of budget i.e. balanced budget, surplus budget, and deficit budget. Let's talk about types of budgets in detail.

1. Balance Budget

In the case of a balanced budget, the estimated revenue shall be equal to the estimated expenditure in a financial year.

Expenditure - refers to spending money or incurring liability for some benefit. Example - Businessman purchased a machine for his business.

If the benefit of expenditure is exhausted within a year, it is treated as an expense (also called revenue expenditure).

On other hand, the benefit of an expenditure lasts more than a year, it is treated as an asset (also called capital expenditure).

2. Surplus Budget

In the case of a surplus budget, the expected revenue surpasses the estimated expenditure in a financial year.

The financial year is also known as the accounting year or fiscal year. It is a period of 12 months for which the Organization generally prepares a financial statement. 

A surplus budget is an indication that a company's finances are being effectively utilized.

3. Deficit Budget

In the case of a deficit budget, the estimated expenditure exceeds the estimated revenue in a financial year. This kind of budget is helpful in times of economic recession and also in boosting the employment rate. 

In times of recession, a deficit budget is helpful in generating additional demand and supports economic growth. In order to achieve this, a government usually covers this amount via public borrowings through government bonds or by withdrawing from its accumulated reserve surplus.

Classification of budget on the basis of Time

1. Long Term Budget

A budget prepared for a period exceeding one year. Long-term budgets are not meant for immediate implementation.

2. Short Term Budget

A budget prepare for a period of less than a year is called short term budget. These budgets are prepared for actual implementation.

3.Current Budget

A current budget is the amount of budget available to spend in the current fiscal year period. This budget is adjusted to the current conditions prevailing in the business

Classification of budget on the basis of functions

1. Master Budget

In simple language, we can say that the master budget is the sum total of all small budgets. It also includes budgeted financial statements, a forecast of inflow and outflow of cash, and an overall financial plan. In a business, top-level management reviews the budget and submits it to the board of directors.

2. Functional Budget

A functional budget is prepared in respect of various functions performed in a business.

a) Sales Budget - Sales budget is a financial plan, which shows how the resources should be allocated to achieve forecasted sales. The main purpose of the sales budget is to plan for maximum utilization of resources and forecasted sales.

Most business owners and managers use "bottom-up" sales forecasting techniques. In other words, they collect sales figures from salespeople in the field because they generally have the most information on what sales will be in the future. The sales figures are then put together to form an aggregate sales forecast.

It is very important to forecast accurate sales because the budget of other departments is based on the sales budget. For example, the production is manufactured as per the sales forecast, but if the sales forecast is not accurate, either the production will be less or more than desired.

b) Production Budget - The production budget is prepared after the preparation of the sales budget. The production budget lists the number of units that must be produced to meet sales needs.

Insufficient stocks can lead to lost sales and high production costs (if produced at the end time).

c) Direct Material Purchase budget-  The direct material purchase budget is directly related to the raw materials needed by the company for its production process. The budget states the amount and cost of each type of raw material needed.

d) Direct Labor Budget- The direct labor budget is used to calculate the no. of labor hours that will be required to produce the units itemized in the production budget.

e) Overhead Budgets- Overhead costs are business costs that are related to the day-to-day running of a business. Unlike operating expenses, overheads cannot be traced to specific costs.

The overhead budget is all that is left from production which is not included in the direct material purchases and direct labor budgets. Examples of fixed overheads expenses are salaries, rent, property taxes, depreciation of assets, etc. Examples of variable overhead budget expenses are advertising and marketing costs, legal expenses, maintenance, repair of equipment, etc.

c) Cash Budget - A cash budget is a company's estimation of cash inflows and outflows over a specific period of time, which can be weekly, monthly, quarterly, or annually. A company will use a cash budget to determine whether it has sufficient cash to continue operating over the given time frame. Without sufficient cash, a business cannot run smoothly.

Classification of budget on the basis of flexibility 

1. Fixed Budget

A fixed budget is a budget that is designed to remain unchanged irrespective of the level of activity attained.  This type of budget is most suitable for fixed expenses, which have no relation to the volume of output

2. Flexible Budget

A flexible budget is a budget that is designed to change irrespective of the level of activity attained.  This type of budget is most suitable for controlling costs. It is more realistic, practical, and useful than a fixed budget.

Writer - Sahil Madaan

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