All companies operate under a budget. Depending on its size, a company can have multiple budgets for varying departments or just a simple estimate of income for the upcoming year. Managers plan their activities and express them in financial terms. Reports of budgeted expenses versus actual expenses are compiled frequently to access the budget’s accuracy and effectiveness.
Typically, a business calculates a budget according to their fiscal year. Then it divides it into quarterly and monthly periods. Managers are the ones responsible for the formation of the budgets in their department. This holds a two-fold purpose. First, the manager is the one to have the most overall knowledge of budget requirements and needs. Second, the manager’s own performance is measured against his budget.
These budgets are then approved by their superiors. Budgets are not hard and fast. They are estimates at best. They are often based on previous figures, using past experience as a guide. However, the company must account for inflation and the fact that the upcoming year’s circumstances may not reproduce similar financial results.
In addition, the manager must consider discretionary costs. Discretionary costs are expenses that can be postponed without affecting the department’s productivity or operations. In order to do so, the manager uses the procedure called zero based budgeting.
A zero based budget must explain every dollar of cost they predict to be incurred, starting at zero. They cannot take into account pre-authorized funds. It does not rely on past sales and expenditure trends as a starting basis.
All of the budget submissions in a large corporation are commonly reviewed by a budget committee consisting of the budget director, president, the senior production, sales and financial executives.