Profit Planning & Budgeting: A Comprehensive Guide
Profit Planning and Budgeting
What is a Budget?
A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period. The act of preparing a budget is called budgeting. The use of budgets to control an organization’s activity is known as budgetary control.
Budgeting, Planning, and Control
Planning and control are linked. Planning is looking ahead to see what actions should be taken to realize particular goals. Control is looking backward, determining what actually happened and comparing it with the previously planned outcomes.
Budgets are financial plans for the future and are a key component of planning. They identify objectives and the actions needed to achieve them. Before preparing a budget, an organization should develop a strategic plan. The strategic plan plots a direction for an organization’s future activities and operations; it generally covers at least five years.
Levels of Planning for Business Activity
- Strategic Planning: Top management long-range decisions.
- Capital Budgeting: Intermediate-range planning.
- Operations Budgeting: Directs the firm’s activity in the short-range.
Responsibility Accounting
Responsibility accounting is a system of dividing an organization into similar units, each of which is assigned particular responsibilities. These units may be in the form of divisions, segments, departments, branches, product lines, and so on. Each department is comprised of individuals who are responsible for particular tasks or managerial functions.
Responsibility accounting, therefore, represents a method of measuring the performance of various divisions of an organization. The test to identify the division is that the operating performance is separately identifiable and measurable in some way that is of practical significance to management. Responsibility accounting collects and reports planned and actual accounting information about the inputs and outputs of responsibility centers.
Budget Types
Imposed Budgets
Best used in startup organizations, extremely small businesses, during economic crises, or when operating managers lack budgetary skills or perspective.
Advantages:
- Requires less time.
- Utilizes top management’s knowledge of overall resource availability.
- Increased plans are incorporated.
Disadvantages:
- Reduces the feeling of teamwork.
- Dissatisfaction and low morale.
- Limited acceptance of stated goals and objectives.
- May stifle the initiative of lower-level managers.
Participatory Budgets
Best used in well-established organizations, extremely large businesses, during times of economic affluence, or when operating managers have strong budgetary skills and perspective.
Advantages:
- Obtains information from those persons most familiar with the needs and constraints of the organizational units.
- Leads to better morale and higher motivation.
- Integrates knowledge that is diffused among various levels of management.
- Provides a means to develop fiscal responsibility and budgetary skills of employees.
- Develops a high degree of acceptance of and commitment to organizational goals and objectives by operations management.
- Is generally more realistic.
Disadvantages:
- Requires significantly more time.
- May motivate managers to introduce slack into the budget.
- May support empire building by subordinates.
Self-Imposed Budgets
A budget prepared with the full cooperation and participation of managers at all levels. A participative budget is also known as a self-imposed budget.
Advantages:
- Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management.
- Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers.
- Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above.
- A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.
The Budget Committee
A standing committee responsible for:
- Overall policy matters relating to the budget.
- Coordinating the preparation of the budget.
The Master Budget
The master budget is the comprehensive financial plan for the organization as a whole. Typically, the master budget is for a one-year period, corresponding to the fiscal year of the company. The use of smaller time periods allows managers to compare actual data with budgeted data more frequently, so problems may be noticed and resolved sooner.