Budget is a financial plan that helps people make the best possible use of their money. It identifies sources of income and assists in planning expenditures. Income and expenses may vary, and so most budgets consist—at least in part—of estimates.
Individuals, families, businesses, governments, and various organizations all use a budget. A child may have only a few dollars to budget. A government budget may involve billions of dollars. But all budgets resemble one another in certain ways.
Budgets help individuals or groups achieve certain goals. These goals vary, but most people hope to make their income go as far as possible by spending wisely. Most people, businesses, and governments have limited funds to spend, and so they must decide which expenses are most important. By preparing a budget, they can make sure that enough money is set aside for items that have the highest priority. A budget also may reveal a need for more income. It thus may cause individuals to work longer hours and governments to raise taxes.
Personal and family budgets
A personal or family budget can plan spending on a weekly, monthly, or yearly basis. Some people keep two separate budgets. One budget covers annual income and expenses. The other covers a shorter period, such as a pay period at a person’s place of employment. For example, a person who receives a weekly salary may plan a weekly budget.
Keeping a budget consists of three major steps: (1) estimating income, (2) estimating expenditures, and (3) keeping financial records.
Estimating income is the first step in preparing a budget. The budget should show the amount of money available after all salary deductions have been made. Such deductions include income taxes, social security taxes, and health insurance payments. Estimating income is easy if the total income consists only of a regular salary. However, income from a personally owned business or profession or income that varies with the number of hours worked may change continually. In such a case, the volume of business done or the hours worked during a previous period may serve as the basis of an income estimate.
Estimating expenditures. Certain major expenses remain the same, month after month. They include rent or mortgage payments, insurance premiums, and monthly installment payments. Money for such items should be set aside first. Many other necessary expenses, including clothing, food, recreation, and transportation, vary from month to month and may be controlled to some extent. These expenses can be reduced by buying less expensive items and by watching for sales in stores.
Expenditure patterns vary from person to person, as well as from family to family. Such factors as age, family size, income, and personal tastes all affect individual spending. Some people save to pay for their children’s education. Others put money aside to buy a home or an automobile. A family with a low income may have to spend most of its money on food, clothing, and shelter.
In estimating expenditures, individual needs must be analyzed and priorities established. For example, a family may decide to spend less on clothing one year so they can take a vacation.
A personal or family budget may include planned savings. A family may want to save a certain amount to use in an emergency, such as illness or unexpected repairs. The budget should have a surplus that can be used for unexpected expenses.
A budget helps people live within a certain income. People may spend more than they earn in one year by borrowing money or by buying items on credit. But sooner or later they must repay the loans or pay for their purchases. They thus reduce the amount of money available for other items in the budget during the repayment period.
Keeping financial records. Most people who have a budget keep a written record of their plan. They also write down their actual expenditures for various items during the budget period. Such a record of actual spending habits helps plan future budgets. For example, a family may find that they have spent less on recreation than they had planned. The family’s next budget could reflect this situation by increasing the amount of money allowed for another item, such as clothing or food.
A budget helps a business company control its costs effectively. It shows the profits expected from various activities of the firm. It also helps management decide which projects are most important for the growth of the firm.
A small company may have one employee who prepares the firm’s budget. A large company may have an entire budget department with a full-time staff. This department is directed by a senior executive called a budget director, controller, or treasurer.
Most businesses depend on sales for their income. This income varies, and so companies must estimate it when preparing a budget. Businesses cannot control all the factors that affect sales, such as the general economic conditions of the country. But firms can influence sales by using advertising, promotion campaigns, and expert salespeople. A business firm can also control its expenses to some extent by better management and by more efficient use of its employees.
Most companies use two types of budget. These types are an overall operating budget and a capital budget.
An overall operating budget summarizes the entire company’s financial plans. It is based on the budgets of individual departments. Most companies prepare an annual overall operating budget, but some also have a monthly or quarterly budget. A company’s advertising, production, research, and sales departments may each prepare a budget. The budget department then combines these budgets and makes any necessary adjustments. For example, the sales department of a shoe company may plan to sell 100,000 pairs of shoes in a certain year. The budget of the production department must include the cost of manufacturing that number of shoes. The advertising department’s budget must show the cost of informing the public about the shoes and urging people to buy them.
Most companies prepare an income statement at the end of the year that is checked by accountants employed outside the firm. The overall operating budget includes an estimate of income for the next year. Firms compare their year-end income statement with the budget estimate made earlier for the same year. This comparison determines the accuracy of the budget and helps a company plan its future budgets.
A capital budget covers certain kinds of expenditures for a period of several years. It includes the company’s expected costs for future construction, equipment, furniture, investments, and land. A capital budget also includes expenditures to replace worn-out buildings and equipment.
In addition, a capital budget shows the proposed sources of funds for the expenditures involved. These sources may include bank loans, company earnings, and the sale of bonds and stock.
Government budgets, like personal and business budgets, involve total revenue (income) and total expenditures. Taxes provide most government income. Important areas of spending in the United States government budget include education, health, national defense, social security, and transportation. Government funds are also used to support programs for community development, foreign aid, and space research and technology.
The U.S. budget is prepared annually, but it covers a fiscal year rather than a calendar year. The government’s fiscal year runs from October 1 to September 30 and is named according to the calendar year in which it ends. The Office of Management and Budget (OMB) prepares the U.S. budget. This federal agency forms part of the Executive Office of the President.
The national budget shows the expected cost of various government activities. It also indicates any increase or decrease in taxes. The budget informs the public about the government’s priorities. It also has important effects on the economy of the nation.
Preparation of the U.S. budget. Each of the various departments of the federal government prepares a budget based on general guidelines received from the President. The department heads then defend their proposed expenditures at hearings held by the Office of Management and Budget. The OMB also receives estimates of government tax revenues from the Department of the Treasury. The Office of Management and Budget then prepares the budget under the guidance of the President, who sends it to Congress. The Constitution requires Congress to approve all government expenditures.
The Congressional Budget Office (CBO) analyzes the budget and suggests changes. The budget committees of the Senate and the House of Representatives set general spending goals based on the suggestions of the CBO. Congress then passes appropriation bills, which specify how much money each government department may spend. If proposed expenditures exceed the spending target, Congress may have to revise the budget by cutting spending or raising taxes. Or Congress may authorize a budget that has a deficit or a surplus. The revised budget is sent to the President for approval.
The OMB receives funds from the Treasury Department and distributes them to all the government departments. A department may not spend more than the amount approved by Congress unless it requests and receives additional funds. The Government Accountability Office (GAO), another federal agency, checks regularly to make sure each government department follows its budget properly.
The budget also shows how the money provided by Congress is spent for specific programs or activities. These programs may be carried out by one or more of the government’s departments or agencies. For example, the Administration for Children and Families, part of the Department of Health and Human Services, administers the Head Start program (see Head Start). Another program, Food for Peace, involves the Department of Agriculture, the Department of State, and other agencies (see Food for Peace).
Program budgeting helps government leaders clearly see the cost of individual programs. These leaders can then compare the costs and goals of competing programs. Such comparisons help the government establish its long-range spending priorities.
Economic effects of the national budget can be grouped into three major categories: (1) distribution of resources, (2) control of economic activity, and (3) distribution of income.
Distribution of resources. The government and private businesses use such resources as land, labor, and money to produce goods and services. The goods and services provided by the government make up the public sector of the economy. Those produced by private businesses make up the private sector. The effect of the national budget is to allocate (distribute) resources between the public sector and the private sector. The budget does this by determining what proportion of the nation’s resources will serve the public sector. That proportion thus is not available for use by the private sector. The budget also allocates resources within the public sector.
Control of economic activity. Government taxation and spending influence the nation’s general level of economic activity. Taxes lessen economic activity by draining personal income and reducing the total spending of the people. Government expenditures pump money into the nation’s economy and increase economic activity.
The national budget balances if taxes equal expenditures. If taxes exceed expenditures, the budget has a surplus, and the high taxes tend to depress the economy. If expenditures exceed taxes, the budget has a deficit, and the high government spending tends to stimulate the economy.
Economists once believed that the national budget should balance every year. But most experts now believe the government should deliberately create a deficit, a surplus, or a balanced budget—whichever is needed to stabilize the economy. See Economics (Modern economics. ).
For much of the late 1900’s, however, the United States Congress was unable to eliminate large annual budget deficits that many experts considered harmful to the economy. As a result, Congress passed the Balanced Budget and Emergency Deficit Control Act of 1985. This act, also known as the Gramm-Rudman-Hollings Act, required that the federal budget be balanced by 1991. In 1987, Congress amended the act to defer the target date to 1993. In 1990, Congress abandoned the 1993 target date but continued working to reduce the large annual deficits. In 1998, the federal budget had a surplus for the first time since 1969.
Distribution of income. The national budget can also determine who bears the heaviest burden of taxes and who benefits most from government expenditures. In planning the budget, the government may design its tax system to lessen the gap between high and low income groups. For example, a progressive income tax, such as the one that is used in the United States, has a higher tax rate for people in a higher income group. However, a sales tax bears more heavily on people who are on the lowest income levels. These people spend a larger percentage of their income on such taxable items as food and clothing.
Government spending also affects various economic groups differently. For example, people with a low income benefit the most from government spending for public housing and health programs.
State budgets. Most state budgets are prepared by the office of the governor. The state legislature must approve the budget before the plan can go into effect. Taxes are the main source of income for the states. These taxes include sales taxes, state income taxes, and excise taxes on gasoline, tobacco, and liquor. In addition, the states receive federal funds. Major state expenditures include those for education, recreation, transportation, and welfare.
Local budgets. A city may have a budget director who works with the office of the mayor or city manager. Local governments receive money from property, wage, and sales taxes, and they get additional revenue from the state. These funds pay for education, police and fire protection, and the general cost of running the city or county.
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