Budgeting is the tool that most business entities use to link the current performance of that business entity to their strategic objective.
The entity breaks its long-term goal, like in ten years or is the market leader, into a short-term objective, called a budget.
In other words, we can say that budgeting is the short-term objective that an entity use as part of its long-term goal. The above is not the only purpose of budgeting—the following are the top four purposes of it.
1) About Planning:
So business planning is essential for the successful technique most businesses always do. Planning includes Financial and Non-Financial.
Financial Planning or Budgeting lists how much the company needs to generate sales revenue from its products or services.
Revenue budgeting sometimes lists down by-product that needs to be sold by the whole entity or list down by division. Revenue Budgeting is forecast based on the last year’s experience by taking into account the economic, political, demand, and relevance.
Budgeting also needs to be linked to the company’s objective. For example, the CEO said the company needs to return on capital of 10% in the next ten years while the current ROC is just 5%.
In this case, the Revenue Budget needs to be just to this expectation from the CEO whether much revenue needs to generate.
Another part that the company needs to plan is expenses that the entity would expect to be incurred, like Cost of Sale, Administration, Salaries, Marketing Expenses, and Others. These expenses need to be forecasted and budgeted.
So that is why I said the Purpose of Budgeting is about planning—planning about the short-term, one year or two years, and planning about the long-term, like two years or three years.
Budgeting could be done by a top-down approach and a bottom-up approach; however, no matter the approach use, budgeting always gets approval from the Board of Directors or the CEO or Directors.
The purpose of the approval is to delegate the responsibilities to management at the operational level.
For example, if the BOD approves the Budget for the company to get at least USD 10,000,000 of Sales revenue per year, then CEO is responsible for making sure that the sales revenue has been met.
This is the significant one about budgeting and making sure you don’t get it wrong. Budget is the short-term objective, and most the business always has their long-term objective and vision, and mission.
As discussed above, to meet the long-term objective, mission, and vision, the company needs to identify the critical success factors to ensure these three things will be met.
Critical Success Factors are the factors that a company needs to get done at best to ensure it meets its objective, mission, and vision.
To ensure that the company gets the CFS done at best, the need to find the right KPI; Budget is part of the KPI. The company needs to set a budget or KIP that links or integrates with CFS, then the objective, mission, and vision could be met.
By contrast, if the company identifies the wrong CFS, selects the wrong KPI, and prepares the incorrect budget, the hen objective, mission, and vision probably could not be met.
Why is budgeting important for motivation? To ensure the success of the company, the right team needs. Staff motivation is part of the management technique to build the right team.
Budgeting is also to help the company motivate its staff to get all of the KIP set done. For example, if the company could hit the target set by BOD, staff will get five months of their salaries, another kind of position, or other recognition.