The Purpose of Budgeting

In the context of business management, budgeting has three different purposes:

• A forecast of income and expenditure (and thereby profitability)
• A tool for decision making
• A means to monitor business performance

Forecast of income and expenditure

Budgeting is a critically important part of the business planning process. Business owners and managers need to be able to predict whether a business will make a profit or not. A budget is basically a model of how the business might perform, financially speaking, if certain strategies, events, plans are carried out.

In constructing a Business Plan, the manager attempts to forecast Income and Expenditure, and thereby profitability.

Tool for decision making

Once the budget has been set, the budget provides a financial framework for the decision making process i.e. is the proposed course action something we have planned for or not.

In managing a business responsibly, expenditure must be tightly controlled. When the budget for advertising has been fully expended, the decision on "can we spend money on advertising" is likely to be "no".

Monitoring business performance

Once a budget is in place, it enables the actual business performance to be measured against the forecast business performance i.e. is the business living up to our expectations.

In the figure opposite, "variance" is the difference between budgeted expenditure and actual expenditure.