The Importance of Budgeting

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The Importance of Budgeting
Budgeting, both as a form of planning and a decision-making tool, is vital to a company. It provides a detailed estimate of how the company expects to spend money in the following period. Budgeting helps firms to prepare themselves and make alterations, if needed, in order to achieve the desired results. Budgets allow firms to better utilize the financial resources available to them. Most companies create their budgets on an annual basis, aiming to obtain a more precise estimate. Some companies use their internal accounting department to create their annual budget; others hire experts from outside the company. In small businesses the owners are usually the ones responsible for creating the firm’s budget. Some companies use accounting software packages to help in the budgeting process. These accounting software allow companies to gather information from different departments and provide accurate and current data to be used in the budget’s creation. Although annual budgeting provides a more current estimate to the company, it narrows managers’ focus to next year’s performance. Managers need to understand that the company wants a balance between short-term goals and long-term performance. For instance, a manager worried about cutting production costs to achieve revenue goals stated in the budget, might postpone machinery maintenance to next year. This action could put the machinery performance at risk. The machinery could work well for that year and present a higher maintenance cost for the following year. To avoid this sort of situation, many companies prepare long-term budgets of three to five years at the same time as the one year budgets. The long-term budgets better demonstrate the effects caused by short-run actions. If a company uses budgets to evaluate managers’ performances as a method of compensation or promotion, it is expected that managers will bias their forecast during the budgeting process in order to enhance their...
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