In the last years endeavours have been made in several health systems to get a firm grip on the explosive cost development in hospitals which amounts to nearly half of all health care expenditures. The fee-for-service system for doctors coupled with the professional autonomy leads to expansion of quality and quantity of services provided. In many systems hospitals are financed on basis of output items as patient days, examinations and therapies. As hospital costs are in the short run preponderantly constant prices fixed at average costs are higher than marginal costs. This situation favours expansion of services as in that case marginal revenue exceeds marginal cost. Inversely the decrease of services provided generates losses for the hospital. In systems, where financing takes place in the way of budgets like the U.K., Denmark and Italy, the authorities have more influence on the cost development in the system. In systems where the hospitals are financed by social security on basis of output, arrangements are now made to bring budgetary elements in the financing of these institutions. In France the "Budget Global" will be applied to services financed by the Sécurité sociale. In Belgium arrangements have been made to contain the amount of patient days allowed for reimbursement and in the Netherlands in 1983 budget-financing has been introduced for all general and teaching hospitals. In 1984 this system also applies to all other intramural institutions. If a way has been found to focus the financing mechanism of these institutions on budgeted costs, the way is open for budgeting these institutions. A very important problem in this context is the budget formula, which will be used to determine the budgets. In this respect a distinction can be made between internal and external budgeting. Internal budgeting is understood here as a process whereby the hospital itself puts a limit to the use of resources or adapts its resources to budget constraints coming from the outside. External budgeting can be defined as the budgetary constraint given from the outside by third parties to the hospitals. Of course, both internal and external budgeting are narrowly interrelated. The distinction between these two ways of budgeting should be sought in the character of the budget formula. External budgeting should be based on global indications whilst internal budgeting should be more differentiated than the external budget formula.(ABSTRACT TRUNCATED AT 400 WORDS)