What Is a Formal Budget?

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Company management typically presents a formal budget to a board of directors each year.
Company management typically presents a formal budget to a board of directors each year. (Image: Jupiterimages/Photos.com/Getty Images)

Businesses and corporations commonly prepare formal budgets, sometimes referred to as a budget process. A formal budget lists and predicts all expenditures, revenue, profit and returns. Formal budgets must have approval by a top management member or an entire committee. Formal budgeting emerged in the 1950s, according to the Inc website.

Modern Formal Budgeting

Budgeting is an important part of any business, regardless of its size. Business and corporate planning rely heavily on formal budgeting. Among other factors, it paves the way for tools to control and determine bonuses and profit-sharing figures. Management of a formal budget needs great care and skill to prevent a company's finances from turning negative.

Budget Process

Budgeting in large corporations is a collective process. Operating units create plans intended to help achieve corporate goals. Unit managers calculate and project sales, overhead costs, operating expenses and capital expenditures for the coming fiscal year. An upper management panel then reviews unit projections, addressing and negotiating any changes. Negotiations are a common part of the formal budgeting process. Once approved, the formal budget plan becomes the road map for operations in the coming year. Monthly and quarterly budget reviews track performance against projections, allowing managers to gauge the need for any changes.

Budget Development

Company leaders develop budgets from the bottom up, and managers strive to meet business goals from the top down. They measure budget performance by meeting or exceeding projections for sales, returns and profits, and by finishing below projected costs. It takes a strong incentive to project the lowest possible positive results and the highest potential negative results in a formal budget. Managers who understand sales and profits and are good at overestimating costs, typically create the most successful budgets.

Benefits and Costs

One of the most significant benefits of formal budgeting is the time managers must take throughout the year to review all aspects of their operation against the budget. This helps managers keep employees focused and provides a plan against which to compare progress. Formal budgeting creates a comprehensive picture of the future and brings awareness of opportunities and barriers. Time is the chief cost of the budgeting process. In some cases, managers may find themselves completely consumed in the efforts to comply with the vast array of requirements established in the formal budget. Unnecessary bureaucratic impositions, and unreliability due to rapid changes within the company, are two common negative factors of formal budgeting.

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