Procurement describes the acquisition of goods or services at the best possible cost, in the right quantity, time and place, for the direct benefit of the firm. The question now arises: how do you prioritize when you only have a limited amount of money to spend? That’s where the role of budgeting comes in.
A budget is a quantitative expression of financial plans. How are budgets useful? Budgets induce management to think systematically about the future. They also serve as a device for coordinating the complex operations of the business, and provide a medium for communicating the financial goals of the firm.
In order to be useful, the budget must be drawn up for a specific time period. Usually, the budget is drawn up for a year. The operating budget for the firm may be constructed in terms of programs or responsibility areas. The program budget is developed in terms of products that are regarded as the principal programs of the business. Such a budget shows the expected costs and benefits of various products and services.
A cost center is responsible for keeping track of costs and expenses. To assess its performance, the actual costs are compared with the budgeted costs. The latter represent expenses that should have been incurred, given the actual activity level. The variance between actual costs and budgeted costs is analyzed for control purposes.
What is the base for preparing the budget? A commonly used base is the level of operations in the current year. Using this, the expected and planned changes in the forthcoming year are identified to develop the budget for that year. Under this approach, referred to as the incremental approach to budgeting, the focus of budgeting is on the operations during the budget period.
In every firm, there is a critical factor which sets a limit to its level of activity. Often, the expected demand is the limiting factor that defines the scope and level of operations. When the demand is fairly strong, the limiting factor may be the production capacity of the firm, which cannot be augmented in the short run. For firms that do not have easy access to the capital market, finances may be a limiting factor.