What is Financial Budget? – Types and Why do Businesses Need Financial Budgets?

A budget is a quantitative plan or forecast for the future of a business in which the business allocates its resources to different departments or activities.

Businesses mostly use budgets to plan for the future. Businesses use budgets as a monitor and control tool to control their actual performance according to the set budget. 

There are many types of budgets that can be used by businesses. For example, businesses use incremental budgets, zero-based budgets, imposed budgets, participative budgets, operating budgets, etc. One particular type of budget that is used by businesses is known as a financial budget.

1) Financial Budget

A financial budget is a budget that is used by businesses to determine both the long-term and short-term incomes and expenses of a business.

Financial budgets are also made by a business to forecast its future position. A business must first prepare an operating budget before preparing a financial budget.

This is because a financial budget requires certain information from the operating budget, for example, information regarding the forecasted sales, production costs, etc. of the business. A business prepares a financial budget after obtaining these figures from its operating budget.

The financial budget of business mainly comprises a capital expenditures budget and a cash budget. Once the business prepares these two budgets, it can formulate a budgeted balance sheet which is also a part of the financial budget.

2) Capital expenditure budget

A capital expenditure budget is a forecast of any planned future capital expenditures of a business. Capital expenditures are expenditures on long-term or fixed assets of a business, for example, plant, machinery, equipment, vehicles, etc.

Similarly, the budget will include any expenditure on the renovation or replacement of these assets.

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The capital expenditure budget of a business depends on the size and nature of the business. A business operating in a volatile industry, for example, the technology industry, may need to make regular capital expenditures to replace obsolete assets and stay relevant in the market.

However, for some other businesses, such as manufacturing industries, once the initial plant and equipment are purchased, capital expenditures may only be limited to the maintenance of those assets.

3) Cash budget

Once a business prepares a capital expenditure budget, it will prepare a cash budget. Cash budgets, as the name suggests, are forecasts related to the cash flows of a business.

These are short-term budgets prepared regularly, usually monthly, over some time. Typically, businesses prepare monthly cash budgets for a year.

A cash budget is prepared by taking all the expected cash inflows of business and deducting all its expected cash outflows from it. It can help the business forecast how much cash resources it will have at the end of each period.

Similarly, it can help the business effortlessly manage its working capital by identifying any expected cash surplus in the future and using it to pay short-term debts or invest it.

Likewise, the business can also identify any future cash shortage periods and make plans accordingly.

4) Budgeted Balance Sheet

Once the capital expenditure budget and the cash budget of the business are ready, it can prepare a budgeted balance sheet. The budgeted balance sheet will obtain any relevant figures from the two above-mentioned budgets. The budgeted balance sheet will also require figures from the operating budget of a business.

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These figures obtained from different budgets are then adjusted in the current balance sheet of the business to prepare a budgeted balance sheet for the business.

Why do businesses need financial budgets?

Businesses need financial budgets for several reasons. Financial budgets can be used by a business to create a financial awareness related to its spending and earnings.

The budget also highlights any cash flow issues for the business, through its cash budget section, and can help the business take proactive actions.

Financial budgets can also help a business recognize any upcoming business opportunities that can be availed by the business.

Similarly, financial budgets can also act as a communication tool with internal and external stockholders of the business regarding plans of the business.

Moreover, financial budgets are one of the main financial planning tools that can be used by a business as they allow the business to forecast its assets, owner’s equity, and liabilities.

Conclusion

Budgets are quantitative plans for the future of a business. There are many types of budgets, one of which is a financial budget. A financial budget is used by businesses to determine the future position and performance of a business.

Financial budgets comprise three sections. These include the capital expenditure budget, cash budget, and budgeted balance sheet.

Businesses need financial budgets for several reasons such as for creating financial awareness, highlighting cash flow issues, recognizing business opportunities, as a communication tool, and for financial planning.

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