A Guide to Annual Budget Allocation

A budget is an estimation of revenues and expenses over a period which is compiled and evaluated consistently (What Is a Budget? Plus 10 Budgeting Myths Holding You Back, 2022). Budgets can be made for one person, many people, a business, a government, or any other money maker and money spender. To manage expenses, prepare for life's unpredictable events, and be able to afford things without going into debt, budgeting is crucial. This article aims to facilitate the concept of budgeting to the reader from a business perspective as well as briefly touch on how to build and manage it.

Figure 1: An illustration of the definition of a budget.

As December comes to an end January awaits around the corner, representing a fresh start. For many businesses worldwide, who choose to follow a fiscal year that starts on January 1st and ends on December 31, the time to start thinking about the next year’s budget has arrived (Tuoliva, 2022). A fiscal year is a one-year period used by all businesses, entities, institutions, and governments to conduct financial reports and allocate their budgets often referred to as budgeting (Fiscal Year: What It Is and Advantages Over Calendar Year, 2022). To facilitate referring to all the institutions' organizations, businesses, and governments as allocators, this article shall refer to them as entities.

The start and end of a fiscal year depends on the function, location, and work of the entity. In the case of the U.S. government, the fiscal year runs from October 1st of the present year to September 30th of the next year (Tuoliva, 2022). Universities and schools, all utilize different fiscal years to accommodate their teaching and working schedule. Statistically in Europe, the most common fiscal year for businesses, both startups and established businesses, is from January 1st to December 31st (Tuoliva, 2022).

Figure 2: An illustration of the definition of a fiscal year.

Budgeting allows its allocator to understand their goals and expected needs in the upcoming year by accurately showing what the entity can afford, and where the gaps in funding are. The budget provides the necessary space to plan beforehand to meet envisioned needs, and to decide what the entity is able to do in a given year. Budgeting encourages effective ways of dealing with money issues while offering motivation to be creative and successful in seeking out other sources of funding and acquiring the required information to best allocate those sources (Paff, 2021). The completed budgets in a crucial element of funding proposals and reports to investors, founders, stakeholders, and shareholders by facilitating the discussion of the entity's financial realities, avoiding surprises, and maintaining fiscal control. The first step of budgeting is building the vision. The long-term vision sets the direction of the company and develops goals and strategies that are built into the budget and are reflected in the master budget. The master budget consists of two major components: the financial budget and the operating budget (Bank of America | How to Create a Budget, n.d.).

Figure 3: A digitalised illustration of vision in business.

The financial budget foresees the use of assets and liabilities and projects them in a balance sheet (Bank of America | How to Create a Budget, n.d.). The operating budget aids in planning future revenue and expenses and results in a projected income statement. The operating budget has subsidiary budgets with projected sales. The sales budget is the foundation of all operating budgets. Management of an entity uses the number of units from the sales budget and the inventory policy to determine the number of units that need to be produced. This information becomes the production budget (Bank of America | How to Create a Budget, n.d.). The production budget is broken up into budgets for materials, labor, and cost all calculated based on the entity’s standards (Bank of America | How to Create a Budget, n.d.). The historic quantities of the amount of material per unit and the hours of direct labor per unit are used to compute a standard to estimate the number of materials and labor hours needed for the expected level of production. Current costs are used to develop standard costs for the price of materials, the direct labor rate, as well as an estimate of overhead costs (Bank of America | How to Create a Budget, n.d.).

Figure 4: An illustration of simple budgeting calculations.

To save time and eliminate unnecessary repetition, the management team of an entity often starts with the current year’s budget and adjusts it to meet future needs. Expenses that are well known are always calculated seeing as they rarely change, such as salaries, benefits, rent or mortgage, utilities, internet provider, memberships, insurance, etc. However, if the company is a startup, naturally no previous budget exists (Chapter 43. Managing Finances | Section 1. Planning and Writing an Annual Budget | Main Section | Community Tool Box. (n.d.). To establish it the following steps must be followed: calculation of net income, setting achievable goals, making a plan, adjusting spending, staying on budget, and regular reviews of the progress or regress achieved. To make the budget as applicable as possible it has to be organized. The best and easiest way to manage it, is through a grid or spreadsheet with a list of funding sources along its top edge and a list of expense categories running down its left-hand edge (Chapter 43. Managing Finances | Section 1. Planning and Writing an Annual Budget | Main Section | Community Tool Box. (n.d.). Ultimately each vertical column will represent a funding source, and each horizontal row will represent an expense category.

Figure 5: An illustration of business management.

There are various strategies to adjust the budget amounts and plan for the future. Budgets can be derived from a top-down approach or from a bottom-up approach (Paff, 2021). The top-down approach depends on the senior management of an entity. The goals, and predicted sales and expenses information is passed from the senior to middle managers, who transmit it downward (Paff, 2021). Each department must then determine how to allocate its expenses while meeting the goals of the entity. The benefit of this approach is that it ties into the strategic plan and company goals and the final anticipated costs are diminished by the vetting (Paff, 2021). Vetting is a process of research and information gathering which is then checked and verified (Paff, 2021). In the top-down approach, the management of an entity dedicates attention to allocating resources to ensure that expenses do not lead to budgetary slack (Paff, 2021). The drawback to this budgeting approach is that the budget is prepared by individuals who are not familiar with specific operations and particular expenses to understand each department’s nuances.

Figure 6: An illustration of the definition of a surplus.

Sometimes things do not go according to plan, thus a budget surplus or a budget deficit may occur. A budget surplus means that extra money is left at the end of the year and it is far more pleasant than a budget deficit which indicates a shortage of money at the end of the year (Chapter 43. Managing Finances | Section 1. Planning and Writing an Annual Budget | Main Section | Community Tool Box, n.d.). The best and most efficient method is to try to stick to the budget, and invest the excess money at the end of the year should a budget surplus occur. A surplus can be used as means of investment for something that the entity really wants or needs to do, such as support in an emergency, improvement of salaries and working conditions, offering bonuses and benefits, opening new career opportunities, expanding the staff, and entering partnerships or collaborations (Chapter 43. Managing Finances | Section 1. Planning and Writing an Annual Budget | Main Section | Community Tool Box, n.d.).

Figure 7: An illustration of the definition of a budget deficit.

In case of a budget deficit, the first step is to close the budget gap as soon as possible. The best way to do that is through remaining capital from a previous investment or savings bank account (Chapter 43. Managing Finances | Section 1. Planning and Writing an Annual Budget | Main Section | Community Tool Box, n.d.). Another option is through raising the additional money needed through grant-writing, fundraising efforts, and events, or ultimately increasing the fees for the product or service offered by the entity. Collaborations with other organizations and entities can also help save money as they allow for both entities to benefit by sharing the costs of services, personnel, or materials and equipment. Reducing and limiting costs is another way to cut expenses, using less electricity, or using recycled paper may slightly help. Ultimately laying off or reducing staff hours as well as removing benefits, is certain to help the budget deficit even though it comes with its own risks (Chapter 43. Managing Finances | Section 1. Planning and Writing an Annual Budget | Main Section | Community Tool Box, n.d.).

Figure 8: An illustration of digital financial growth.

In conclusion, budgeting is a crucial life skill for all individuals and institutions. It holds a particular significance to the success of an entity and the continuity of profit increase. Putting together a budget is a simple procedure that requires a prevision of all expenses, liabilities, and estimated revenue. Establishing a budget may be slightly more difficult if the entity seeking to create it is a startup because the percentage of estimation increases and reoccurring digits decrease. Budgeting may result in a surplus or deficit depending on the events that unfold during the fiscal year. Each budgeting method and outcome corresponds to its own solutions and applications to eliminate the problem and inspire growth.

Bibliography

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Chapter 43. Managing Finances | Section 1. Planning and Writing an Annual Budget | Main Section | Community Tool Box. (n.d.). https://ctb.ku.edu/en/table-of-contents/finances/managing-finances/annual-budget/main

Alicia Tuoliva. Fiscal Year: What It Is and Advantages Over Calendar Year. (2022, March 6). Investopedia. Pressbooks. https://psu.pb.unizin.org/acctg211/chapter/budgeting-basics/

Paff, L. (2021, February 5). 10.1 Budgeting Basics – Financial and Managerial Accounting. Pressbooks. https://psu.pb.unizin.org/acctg211/chapter/budgeting-basics

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Visual Sources

Figure 1: What Is a Budget? Plus 10 Budgeting Myths Holding You Back. (2022, May 28). (Illustration) Investopedia. https://www.investopedia.com/terms/b/budget.asp

Figure 2: Fiscal Year: What It Is and Advantages Over Calendar Year. (2022b, March 6).(Illustration) Investopedia. https://www.investopedia.com/terms/f/fiscalyear.asp

Figure 3: Vision and Core Values - Robotic Process Automation. (2020, March 5).(Illustration) Auxiliobits. https://www.auxiliobits.com/vision-and-core-values/

Figure 4: Bond, C. (2019, October 8). (Illustration) How To Budget When You Absolutely Hate The Idea Of Budgeting. HuffPost. https://www.huffpost.com/entry/how-to-budget-template_l_5d8bed10e4b0019647a2b2cd

Figure 5: Dingani, S. (2020, May 4).(Illustration) How to Master the Four Functions of Management. The Human Capital Hub. https://www.thehumancapitalhub.com/articles/How-To-Master-The-Four-Functions-Of-Management

Figure 6: What Is a Surplus? Definition, Reasons, and Consequences. (2022, October 4).(Illustration) Investopedia. https://www.investopedia.com/terms/s/surplus.asp

Figure 7: Budget Deficit: Causes, Effects, and Prevention Strategies. (2022, September 7). (Illustration) Investopedia. https://www.investopedia.com/terms/b/budget-deficit.asp

Figure 8: Dunne, S. (n.d.). (Illustration) How Finance Must Rethink Skills to Thrive in the Digital Era. Workday Blog. https://blog.workday.com/en-us/2020/how-finance-must-rethink-skills-thrive-digital-era.html