Budgeting: Planning and Control in Organizations
What Is a Budget and Budgetary Control?
A budget is a quantitative plan for acquiring and using resources over a specified time period. Once the budget is established, actual spending is compared to the budget to ensure adherence to the plan. Budgetary control involves the steps taken by management to increase the likelihood that all parts of the organization are working together to achieve the goals set during the planning stage. An effective budgeting system must provide for both planning and control. Good planning without effective control is unproductive.
Major Benefits of Budgeting
Organizations realize many benefits from budgeting, including:
- Communicating management’s plans throughout the organization.
- Forcing managers to think about and plan for the future, preventing them from solely focusing on daily emergencies.
- Providing a means of allocating resources effectively.
- Uncovering potential bottlenecks before they occur.
- Coordinating the activities of the entire organization by integrating the plans of its various parts, ensuring everyone works towards the same goals.
- Defining goals and objectives that serve as benchmarks for evaluating subsequent performance.
Responsibility Accounting
Responsibility accounting is based on the principle that a manager should be held responsible only for those items they can significantly control. Each line item (revenue or cost) in the budget is assigned to a responsible manager who is held accountable for deviations between budgeted and actual results. Responsibility accounting personalizes accounting information, making individuals responsible for revenues and costs. This concept is crucial for effective profit planning and control.
The Master Budget and Its Contents
The master budget comprises several interdependent budgets. The process begins with the sales budget, a detailed schedule of expected sales for the budget period. This informs the production budget, which determines the number of units to be produced. The production budget then drives the budgets for manufacturing costs, including the direct materials budget, the direct labor budget, and the manufacturing overhead budget. These budgets, combined with data from the sales budget and the selling and administrative expense budget, determine the cash budget, a detailed plan for acquiring and using cash resources. Finally, the budgeted income statement and the budgeted balance sheet are prepared.
Importance of the Sales Forecast
The sales forecast is the starting point in budgeting because all other budget items, including production, purchases, inventories, and expenses, depend on it. The process unfolds as described in the previous section.
Planning vs. Control
Planning and control are distinct but related concepts. Planning involves developing goals and preparing budgets to achieve them, while control involves ensuring the organization works towards these goals. A good budgeting system requires both. Planning without control is ineffective.
Planning is forward-looking, determining actions to achieve goals. Control is backward-looking, comparing actual results with planned outcomes. Budgets, as financial plans, are key to planning, identifying objectives and necessary actions. Strategic planning, which sets the direction for future activities and operations (typically covering at least five years), should precede budgeting.