Why Budgeting is Important in Cost Accounting
In cost accounting, when you put together a budget, you determine how you plan to use your resources. Assets are resources; cash is the most famous asset. Other property, like vehicles, for example, are assets, too. The reason you spend cash for materials and labor is to earn money for your business. The reason you buy a truck for use in your business? Same thing: to earn money for your business.
In theory, you could sell all your assets. Of course, then you wouldn’t have a business, but that’s what happens when you dissolve a business — the assets are used to pay off the company’s liabilities. A liability represents a claim on your assets. A claim means that someone has a potential right to your assets if you don’t pay him or what you owe.
A bank loan is a company liability. So are your utility bill and other bills you need to pay. If you don’t pay your bills, the companies you owe could file lawsuits. A court might force you to pay. That’s what is meant by a claim on assets.
A budget helps you forecast how much of your assets you use and how much revenue (sales) the asset generate. If you use your assets (resources) wisely, you increase your profit.
Assets such as trucks depreciate. They’re worth a little less every day as you use them up. The more you drive your company trucks, the more costs you recognize. Note that you can budget for operating costs and depreciation, such as what you’ll see with a truck.
Take landscapers as an example. Landscapers are a smart bunch. They drive the wheels off their trucks until maintenance costs become too great. They milk all the revenue they can out of an asset before disposing of it. It’s simple: A load of steer manure doesn’t care whether it’s being driven to the jobsite in a brand-new dually with crew cab or a 15-year-old junker.
You have choices about using resources. If you choose to use resources to make product A (and generate revenue), you’re giving up the opportunity to use those same resources to produce product B (which would have generated revenue, too). This is called opportunity cost. You make the decision to produce either product A or B in your budget.
Opportunity cost is the decision to go one way instead or the other. It’s mainly about deciding how to allocate resources. Opportunity cost confronts you when you look at your product line (what you plan to sell), your expenses, your vehicles, and so forth. It even operates when you choose which restaurant to go to on Saturday night. Maybe the pricey place is close by and the cheaper place is a long way away, so what do you do? Either option gives you something and costs something.
Cash flow is the cash inflows and outflows your business generates. When you produce a product or perform a service, you spend cash (cash outflow). When you’re paid for a sale, you get cash (cash inflow). You plan sales in your budget. As a result, you plan cash inflow and outflows, too. The key cash flow question is this: Does my budget include enough cash inflows to pay the outflows?
If an accountant recognizes revenue based on cash inflows, he or she is using the using cash basis accounting. Cash basis accounting recognizes expenses when you have a cash outflow.