Budget as an Operating Plan
All managements make plans. A group of people not operating under some sort of plan is incoherent, directionless and not an organization. In any organization such as a company operating a business, the leaders (the managers), give much thought to what the objectives should be and the best way of reaching them. Although all managements plan, there are wide differences in the way in which
they plan. Some people do their planning entirely in their heads.
Others make notes and rough estimates on the backs of old envelopes! Still, others express their plans in quantitative terms and commit these to paper in some orderly, systematic fashion. Some 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 units of product, number of employees, units of time, or other non-monetary quantities. As well as its planning function, the budget is also a control and co-ordination 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.
In budgeting, every member of management 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 upon, 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 include a review of operating at each stage in the budgeting process. The review ensures that the operating plan represents the optimum use of resources.
The ultimate responsibility for the budget is the accountable manager’s. High standards in setting operating plans develop cost and profit conscious attitudes in the whole management team. This makes effective use of the budgeting process.
i. People Skills
The budgeting process should be perceived as a means of expanding job interest and increasing people’s value to the company. This needs great skill in dealing with people by senior managers and the accounting staff who generally administer budgets. They have to know the management team, and the personalities involved and be aware of the different approaches which best suit individuals.
ii. 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.
Create conditions where management has the competence and the will to work towards 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
iii. End Result
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 costs 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 of itself will not lead to profits; managing to the operating plan will help to achieve the profit objective contained in the plan.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.