Do you plan finances with a budget? Or are you someone who thinks it is unnecessary, boring, and a jargon used by accountants only? If you are not familiar with this term, it is easy to wonder why it is important, and you may associate it with hassle and restrictions. A budget plays a vital role in any person or company’s financial success.
A budget helps you achieve your financial goals by keeping your expenses from getting messy. This article intends to discuss functional budget, why it is important, and the different types of budgets in management accounting.
What Is a Budget?
Simply put, a budget is a financial map for a specific period. Essentially, it outlines the revenue and spending over a defined period. Similarly, the process of creating a budget is called budgeting. A budget holds paramount importance for the financial success of a family or company since it keeps the expenses in check.
Types of Budget
Different types of budgets contribute to crafting a perfect financial plan for a business. The final budget of a business organization is a combination of different budgets. The following are two types of budgets:
- Master budget
- Functional budget
The master budget is not a single budget; it is a set of different budgets that outlines future sales, expenses, and expected production. It is used as a planning tool and provides the company with a financial plan for a given period of time. It helps an organization determine whether its financial goals will be achieved in a fiscal year or not.
In simple words, a master budget is a comprehensive budget that helps a firm keep track of their spendings and revenue. It is a combination of different lower-level functional budgets. This way, a company will be able to analyze its finances and adopt a more financially viable strategy.
A master budget is crafted in most companies after taking feedback from various employees in different departments. It is usually made by the finance committee of a business organization and is approved by the budget director.
How Is a Master Budget Crafted?
Deciding the financial year goals is the first step in creating a master budget. After that, all small budgets are prepared and combined to make a master budget. Of course, it is a time-consuming process and requires great skills and knowledge.
Preparing budgets is an example of the management function. Once an organization has decided its financial goals for a year, the budget director asks departmental heads to prepare individual budgets. The process usually starts with a sales budget, and a company first calculates its expected sales.
Apart from that, a company also decides the products that it is expected to purchase; it could be a manufacturing plant or other tools and equipment, and the amount likely to be spent on those purchases. After getting budgets from different departments, all of them are combined to craft a master budget.
What is Functional Budget?
As the name suggests, a functional budget is a budget that represents the different functions of a company. In other words, a functional budget refers to the expenses and income of individual functional areas of a company.
Of course, there are many functions in a business organization, such as sales, marketing, production, and so on. It allows a company to analyze the individual departments.
A functional budget is a crucial aspect of any organization’s financial plan. Functional budgets of different departments help you create a perfect master budget. They are short-term financial tools and provide a company with the data it needs to create a master budget. For a company to prepare an accurate master budget, it must create an accurate functional budget.
Types of Functional Budget
The functional budget varies with the departments. It goes without saying that different departments will have different budgets, and the functional budget encompasses both direct and indirect expenses involved in a particular function.
Direct costs of a company could be easily identified. It includes obvious costs, such as employees’ salaries, spending on tools and equipment, and so on. On the other hand, indirect costs refer to overhead costs, such as taxes, bonuses, security, and so on. They are harder to calculate than direct costs since they are challenging to identify.
For example, a budget director or accountant cannot know how much a company will spend to pay for its employees’ overtime.
Examples of a Functional Budget
Sales, production, and marketing budgets are some of the many examples of functional budgets.
Without an iota of a doubt, the sales budget is the most important functional budget. It is often the first one to be calculated. It shows the sales a company is expected to achieve in a given period. So, it would be safe to say that the other budgets heavily depend on the sales budget.
The sales budget is given utmost importance, and although the budget director makes sure that it is calculated perfectly, you cannot expect it to be exactly accurate. It is prepared after considering the previous sale records, product type, and consumer trends.
The production budget includes the expected costs of installing new production plants. It depends on the sales budget as the production units will be installed depending on the sales projection of any product. It covers the costs of the plants as well as the costs of the labor.
The marketing budget is another functional budget example. Nowadays, marketing is paramount for any company’s success. However, you cannot shell out all your money carelessly on marketing. A marketing budget keeps your marketing expenses under control.
A marketing budget is a plan that shows the amount a company is likely to spend on advertising. It mainly depends on the medium the company chooses for advertising. Whether your company chooses costly mediums (TV ads, radio ads) or relatively less expensive mediums, such as social media ads, it will affect the total budget.
For the best results, consider researching your target audience and their trends. The competitor analysis will also help you determine the right marketing strategy.
Importance of Budget
The major purpose of a budget is to provide a company with a financial plan. No matter how big or small an organization is, there is no denying the importance of a budget. From the salary of your employees to production costs, it could be challenging to keep track of your expenses.
A budget allows you to figure out your total expenses and revenue, allowing you to keep your expenses under control. Of course, how will you overspend money if you know you are low on a budget? The lesser your expenses are, the more money you will save. Hence, a budget creates financial stability and helps you achieve your financial goals. Furthermore, it also helps you invest your money in the right places.
A budget is important for every business as it provides a financial plan. While a master budget is a comprehensive budget, the functional budget is a financial plan that focuses on a particular function. It includes both direct and indirect costs of a department or function. Sales, production, and marketing budgets are some of its examples.