Budgeting

• Author: Kevin Nelson, Scott Droege
• Pages: 49-50

Page 49

Organizations develop specific plans for saving and spending income and these plans, or budgets, are essential for developing spending and saving priorities. Properly preparing a budget also serves as a reference to check how well money is being managed during a period by allowing managers to see actual revenues and expenses compared to budgeted revenues and expenses. Corrective action can be taken earlier in a period when revenue shortfalls or expense excesses are identified.

The term "budget" can be dated back to medieval England, where it meant "leather purse" or "wallet." A budget allows businesses to meet specific goals by creating a system of saving and spending money efficiently. Simply defined, a budget is a plan for using corporate funds in a way that best meets the firm's wants and needs. The plan includes a recorded entry of expected income, expenses, and savings over a defined period of time.

A wide range of budgeting techniques exist, and although the fundamental purposes are similar, the specifics among various organizations are often different. One important aspect of budgeting is how organizations increase cash to finance ongoing operations and new opportunities. Large corporations, for example, may have the option of increasing cash by selling treasury stock (previously authorized shares of ownership that have never been offered for sale on the stock market). The liquidity of equity (stock) markets allows managers to implement these equity decisions fairly quickly to budget for projected needs. In addition, the debt-paying ability of large corporations is rated by several independent organizations. This creates a market for corporate debt, more commonly referred to as bonds. Corporations with favorable debt ratings have the ability to borrow money; that is, issue bonds, at lower interest rates than those with unfavorable debt ratings. Small businesses, in contrast, often do not have publicly traded shares of stock. Although these businesses can sell stock to investors, the process is more uncertain because the market for this type of stock is less liquid. Venture capital is also an option, but the number of small businesses seeking venture capital nearly always exceeds the amount of venture capital available. Also, debt-rating agencies do not rate the debt-paying ability of many small businesses, limiting the extent to which these businesses can raise cash through bond issues. Without a ready...