What is a budget and why do we need it? Planning to save some money?
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Learn more from the full courseFinancial Planning & Analysis: Building a Company's Budget
Learn the Fundamental Mechanics of Financial Planning and Position Your Career for Success!
01:34:07 of on-demand video • Updated June 2020
- Prepare a Company's Budget from Scratch
- Perform Top-Down and Bottom-up Forecasting
- Forecast a Company's Sales
- Forecast a Company's Planned Level of Production
- Calculate Net Cash Flow
- Forecast Various Types of Expenditures
- Estimate Working Capital Needs
- Carry out a Fixed Asset Rollforward
- Build an Integrated Financial Model
English [Auto] What is a budget and why does a company need it. The answer is not that difficult actually. Think of a budget as a map of where a company is going and as it is in any journey without a map it is easy to get lost or forget where we wanted to get in the first place. A company's budget contains the goals set for the next year or the next couple of years and includes a detailed plan of how to achieve these goals. Planning identifies potential opportunities and bottlenecks in advance and helps management make many important decisions when leaving the company towards its goals. Almost every company uses a budget in its daily operations. The gelato shop on the next corner does it and so does Wal-Mart. Planning is an essential part of corporate finance and is a key tool for any firm that wants to stay in business. A practical example can be helpful. Think of your personal finances. Let's say that at the beginning of the year you come up with a goal your goal is to save $1200 next year which is significantly more than what you have saved in previous years. There are two ways to achieve the desired outcome. The first one is to go with the flow and hope that at the end of the year we will turn out with savings of $1200. I think you will agree that the chances of success of this strategy are not very high. Keeping in mind what has happened in the past. The other option is to make a plan a personal budget and be prepared for what comes next. This option sounds a lot better right. If you prepare a detailed plan that shows the exact steps that must be taken to save twelve hundred dollars you are much more likely to follow these steps and succeed. What is a personal budget consist of. We will have your personal income on one side and the expenses you will have on the other side. Imagine the following. You earn an income of thirty thousand dollars and you pay to the government income taxes of $7000. So your take home pay is equal to $23000. Right. However every person uses their income to afford a living. You need to pay for many things the house where you live cost $6000 per year the utility bills they come in the mailbox costs $3000. The food you buy in the supermarket and restaurants cost another $6000. Every normal person likes to have fun and spend some money on entertainment. Cinema tickets tourist trips and so on. Thats why we also plan that you will spend $5000 for entertainment. OK. It is reasonable to expect that during the year some smaller expenses will occur to now and then you will have to pay for things like taxis cosmetic services parking and many other small things. Lets play on that. These expenses will amount to $3000 over the next year. And finally you will have to repay $3000 for a debt which are on three years ago a debt that seemed like a good idea at the time and helped to refurnish the apartment your rent. So these are pretty much all of the cash inflows and outflows you will have during the year. But wait a minute. The left and right columns add up to a negative balance which shows we will spend more than Maller it is good we agree that going with the flow is not the best approach. Now if we want to achieve savings of twelve hundred dollars at the end of the year we have two options earn more or spend less. It's not a difficult equation is it. OK. Let's consider what you can do to earn more. Fortunately enough your job is very flexible and then allows you to work extra hours every week. By staying a little later in working an hour or two more you can earn extra cash. If you do that throughout the whole year you will be able to generate an additional $2200. However according to your calculations here you'll need another $2000 to reach the goal of saving $1200. We will have to cut some of the year's expenses. Some are fixed taxes rent debt repayment and utility bills but others are a lot more flexible. After carefully studying the various expenses you decide that $5000 for entertainment is too much consisting of two denounced per week. You could cut one of them as you are in a saving mode and this will save you exactly $2000. Having this guide and following it increases your chances of saving the desired amount. It is pretty much the same thing with companies. The budget they prepare stays behind their operational plan and it wasn't a plan what will occur in the business over the next 12 to 18 months. Of course companies operate at a larger scale and we will have to consider many details when preparing their budget. We will learn how to do that in our next lessons. The aim of this lesson was to show you how important it can be for an individual and especially for a firm to plan their finances well in advance. We would like to offer you a challenge. You saw the personal budget we prepared here right. Why don't you try to prepare a similar budget for yourself. Build a nice spreadsheet or use the template attached to this lesson. Organizing your finances and preparing a budget for the next period can be extremely useful. We would be pleased to hear the outcome of this exercise. Feel free to post your stories in the course discussion board and tell us whether you are positively or negatively surprised by comparing the budget to your actual spending. That's all for now. Thank you for watching.