Budgeting

In order for an organization to align the budget with the strategic plan, it must budget for the day-to-day operations of the business. This means the company must understand when and how many sales will occur, as well as what expenses are required to generate those sales. In short, each component – sales, production, and other expenses – must be properly budgeted to generate the operating budget components and the resulting pro-forma budgeted income statement.

The budgeting process begins with the estimate of sales. When management has a solid estimate of sales for each quarter, month, week, or other relevant time period, they can determine how many units must be produced. From there, they determine the expenditures, such as direct materials necessary to produce the units. It is critical for the sales estimate to be accurate so that management knows how many units to produce. If the estimate is understated, the company will not have enough inventory to satisfy customers, and they will not have ordered enough material or scheduled enough direct labor to manufacture more units. Customers may then shop somewhere else to meet their needs. Likewise, if sales are overestimated, management will have purchased more material than necessary and have a larger labor force than needed. This overestimate will cause management to have spent more cash than was necessary.