In every organization, management makes plans. A group of people operating without some sort of plan is incoherent, directionless, and not an organization.
In any organization, such as a company operating a business, the leaders (i.e., the managers) dedicate considerable thought to the question of what the firm’s objectives should be and the best way of reaching them.
Although all managements plan, there are differences in the way in which they do so. Some people do their planning entirely in their heads or they use sheets of paper (even envelopes!) to make notes and rough estimates.
Others express their plans in quantitative terms and commit these to paper or a digital record in some orderly, systematic fashion. Some even use computer models.
However it is done, this process is called budgeting. A budget is a plan expressed in quantitative terms. Our concern is mainly with budgets that are expressed in monetary terms.
Some budgets are expressed in terms of units of product, employee numbers, units of time, or other non-monetary quantities.
As well as its planning function, the budget is also a control and coordination mechanism.
The diagram below illustrates the range of budgets that are possible, as well as the distinctions between the operating and responsibility budgets. As individuals, we are mostly concerned with the latter.
Purpose of Budgeting
In budgeting, every member of an organization’s management team should become involved in the financial planning and control process. Budgeting may be described as:
- Establishing requirements and objectives for all accountable managers
- Preparation, by each accountable manager, of a detailed operating plan for the department (this will meet, or improve on, the departmental objective)
- Consolidation of all operating plans into a master budget
- Reconciliation of the result with the profit objective
Budgeting is a creative part of the management process. So, a review of operations is included at each stage in the budgeting process. The review ensures that the operating plan represents the optimal use of resources.
The ultimate responsibility for the budget is the accountable manager. High standards in setting operating plans develop cost-conscious and profit-conscious attitudes across the whole management team. This makes effective use of the budgeting process.
The budgeting process should be perceived as a means of expanding job interest and increasing people’s value to the company. This requires great skill in dealing with people from senior managers and the accountants who generally administer budgets.
They have to know the management team and the personalities involved, and it is also necessary for them to have a clear awareness of the different approaches that best suit individuals.
Create the Right Conditions
There must be a mechanism (e.g, budget coordinator) to provide the linkage between all sections of the management team and their information sources.
This creates conditions in which management has the competence and the will to work toward the achievement of their own and the company’s objectives. These conditions include:
- Top management commitment
- Delegation through a management structure
- Accountability for planning and control
The end result of this effort is an operational budget for the company for the period of the plan. It includes the master profit plan, which shows the profit objectives. The subsidiary budgets include:
- Department income and revenue budgets
- Production cost budget
- Budgets for current and fixed assets
- Cash budget
Each of these subsidiary budgets contains financial targets for individual managers. These are the plans prepared by the manager for the department.
The operating plan—in and of itself—will not lead to profits; however, effectively managing and implementing the operating plan will help to achieve the profit objective contained in the plan.