What is budgeting?

Budgeting is the process of building budgets, i.e. a quantification of the resources to be acquired and used during a given period of time to achieve a plan.

A budget is the detailed document translating in financial terms a plan of action over a limited time horizon, typically a year, which can be broken down to shorter periods, typically quarters and months. It specifies short-term objectives and how resources should be acquired and used to achieve these objectives.

Budgeting relies heavily on techniques seen in prior chapters, especially cost estimation (Chapter 3), and is necessary for the implementation of variance analysis which we will cover in the next chapter. It is literally the first step of a financial implementation of the control cycle popularized by Edward Deming: budgeting (Chapter 5) results in the plan, variance analysis (Chapter 6) structures the check, and differential analysis (Chapter 7) or cost estimation (Chapter 3) support the act.

Budgets serve many important purposes in organizations and are one of the cornerstones of management control systems. However, this multiplicity of purposes raises some challenges which led to severe criticisms against this tool. At the end of this chapter, you should be able to:

  • Explain the functions of budgets;
  • Describe the budgeting process;
  • List and describe the different components of a master budget;
  • Explain the criticisms against budgets;
  • Explain the improvements, complements, and alternatives suggested to overcome these criticisms.