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Author: James Howard

This lesson discusses the need for budgets within an organization.

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Hello and welcome to this tutorial on budgeting. Now, as always with these tutorials, please feel free to fast forward, pause or rewind as many times as you need in order to get the most out of the time you'll spend here. Let me ask you a question. What is a budget? Now, I know we've all heard this term before. And we've actually talked about it a little bit in some earlier tutorials. But why is it do you think a budget is important to a business? Well, during this tutorial, what we're going to be looking at is budget for business.

We're also be looking at budget and survival. The key terms we're going to be looking at in this lesson are budget, cash budget, and capital budget. So what's a budget? Let's go ahead and define that right off the bat. A budget is a research projection of what funds are needed for a specific period of time.

Now budgets are used for a lot of different things. And they're used for things like planning, controlling, and making decisions within a business. And it's important to have a budget to compare to the actual expenses and revenues. You see, differences among your goals, or what you plan for in your budget, and reality, can spell potential problems and may require you to take some action along the way in order to mitigate those problems down the road.

Now, budgets can be anywhere from one to five years. And typically, with one-year budgets, you see things that are much, much more specific. And budgets are dispersed to lower levels of the organization throughout the company, such as department budgets and project budgets. So you start with a budget for the entire company and then you ask lower divisions or departments to come up with their own budgets that are in line with the budget that you've come up with for the entire company.

Now, cash budgets, this is the defined immediate cash needs for an organization for a specific and short period of time. Now, these budgets are good for keeping track of, or recording, things like weekly performance. Things where I'm looking at almost day to day operations and how my cash is being affected.

Now, a capital budget is an analysis of the acquisition of new, long-term investments, such as a building or R&D, as to whether the organization will be able to successfully afford the investments. So you see this is quite important, because you don't want to be spending money on capital that you can't afford down the road. And typically, this is used for big, big ticket items, like buildings, as we mentioned. And this involves the cost of acquiring the item, well, that's called capital budgeting-- the big, big thing that is long-term in the budget.

So let's talk a little bit about budget and survival. Now, organizations have to meet their short-term needs, or short-term debts. And also, they have to meet the long-term liabilities. And there are two key ratios that we use to make sure that we can do that. One is called the current ratio, or current assets versus current liabilities. Current assets divided by your current liabilities. And this gives you something called the current ratio. And this is used to show how likely a company is to be able to pay off their current debts. How credit worthy is it?

Now it's generally desirable to have a high current ratio. Because it's likely that the organization will be able to pay its debts. Now, as an example, 2 to 1 is typically considered acceptable within a business. Now, let's say I have $4,000 in current assets, things like cash on hand. And I have $1,000 worth of current liabilities, so short-term loans that I've taken. In this case, my current ratio would be 4 to 1. I have four times as many assets as I do current liabilities. So that's a pretty good score. That's something I should be really, really happy with.

Now the next thing we want to look at, as far as budget and survival, is debt to owner's equity, or D, debt, divided by the owner's equity in a company. And this is used to show how aggressively a company has been growing in debt. And it's generally desirable here to have something that's a low number, a low debt to owner's equity ratio. Because it shows that the organization is not relying on debt too much in order to keep its business operations going.

Now here, I have an example where I have $4,000 in debt, and I have $5,000 in owner's equity. In this case, I have a debt to owner's equity of 0.8. And this is considered pretty good, because it's less than 1. So basically, what it means is the total amount of owner's equity-- remember from the balance sheet? $5,000 is greater than the amount of debt that I have. And this is typically considered a good position to be in for a company.

So what did we talk about today? Well, we looked at budget for a business. And we also looked at budget and survival and those ratios that we can use to help gauge how healthy or credit worthy we are as a business. Now as always, I want to thank you for spending some time with me today, and you folks have a good day.

Terms to Know

A researched projection of what funds are needed for a specific period of time.

Capital Budget

Analysis of the acquisition of new long term investments (such as a building or R&D) as to whether the organization will be able to successfully afford the investments.

Cash Budget

The defined, immediate cash needs for an organization for a specific, and short period, of time.