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Theories of a Budget

Original post by David Carnes of Demand Media

Budgeting theory can be used by consumers and companies.

Budgeting is necessary to determine whether a project is financially viable, to avoid cost overruns, to prevent waste and to secure financing. Costing is a component of budgeting and is a necessary precondition to all other phases of the budget planning process. Budgeting can be divided into the planning phase and the control phase.

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Costing

Costing integrates many elements to produce an overall cost estimate. These include cost per man/hour of labor, marginal costs, cost over a particular time period, cost of resources, initial capital costs and ongoing operational costs. Which method you focus on depends on the type of industry and the type of project you are budgeting. Some construction projects, for example, require high initial investment but relatively low ongoing maintenance costs. Some projects, such as IT projects, are capital-intensive, while others are labor-intensive.

Budgeting: The Planning Phase

The overall budget planning phase differs from the costing phase in that the budget planner takes a broader view. You must identify specific resources -- such a labor availability or sources of financing -- that are necessary for each phase of a project. A budget planner also looks at cost elements for various aspects of a project and identifies how they interrelate. This can help discover potential bottlenecks and redundancies.

Budgeting: The Control Phase

The control phase of budgeting occurs after a project has begun. The object is to keep costs under control and, if possible, complete the project under budget. In the control phase, you must rationally adjust your course in response to contingencies. For example, a project may be running behind schedule. Ironically, this can lead to unjustified optimism because many scheduled costs may not have been incurred yet. If the project is running ahead of schedule, apparent cost overruns may be illusory, because costs scheduled for tomorrow are being incurred today. If your suppliers are making early deliveries, you may need to ask them to stop doing so if the supplies are not being used immediately, because storage expenses can result in cost overruns.

Pitfalls

Common pitfalls in the budgeting process include lack of prudence, lack of candor and over-reliance on third-party estimates. Prudence dictates that during budget planning you should think pessimistically to allow a wide margin of error for unexpected contingencies. Project managers often deliberately misrepresent the true cost of a project to their superiors, preferring instead to ask for repeated incremental increases in funding or other resources. Budget planners commonly over-rely on optimistic cost estimates received from suppliers and subcontractors.


                   

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About the Author

David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.

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