Budgeting

Definition of

Budgeting is a business planning process in which budgets for business units and departments are planned and approved. It defines targets to be achieved within a planning period. Specifically, it involves estimating the revenues and expenses of a business entity over a specific period in the future. This period is typically twelve months, or one fiscal year. A budget allows a company to assess how well it is likely to perform over the course of the year. One of the goals of budgeting is to steer and implement liquidity targets.

What are the different types of budgeting?

In general, budget planning can be divided into operational and strategic financial planning. While operational budget plans aim to create short-term budgets and typically have a time horizon of one year, strategic budget plans focus on long-term planning. Accordingly, the time horizon here is longer, ranging from two to five years.

In addition, there are different types of planning. One is top-down planning, also known as retrograde budgeting. In this approach, planning is based on guidelines provided by senior management. The other is bottom-up planning, also known as progressive budgeting. In this approach, budget proposals from project or department heads are submitted to management. Often, both approaches are combined in what is known as the counterflow process. Here, planning by senior management is followed by feedback from the respective departments, ensuring that all stakeholders relevant to the planning process are equally involved.

How does budgeting work?

Depending on the type of budget planning, the process can be broken down into varying numbers of steps. Below is an example of how a budget can be created in five steps.

1. Information about the previous period, current revenue, and other factors is collected, and a forecast of budget-related factors is prepared.

2. Based on the information gathered in advance, management sets budget targets for the company (top-down).

3. The individual departments plan their budgets (bottom-up).

4. The Controlling department reviews the budgets that have been prepared and works with management to optimize them.

5. Management approves the budget.

In addition, the budget must be reviewed regularly to ensure that budgets are adhered to and that deviations from the original plan are documented.