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Financial Planning and Budgeting

Developing budgets can be highly complex and detailed or simple and straightforward. The degree of complexity is driven more by the needs and environment in which the entity operates. As an example, a sole proprietorship serving a relatively small market space can operate to a much simpler budget than a large, global, publicly traded enterprise. The common denominator for all budgets and financial planning processes and projects is clarity. The objectives, outcomes and measures have to be clearly communicated and understood by all in the organization.

In simplest terms, budgeting is the process of developing formal plans for future business activities. The formal plans and statement of desired future activities is called the budget. The objective is to provide management with a clear understanding of all the activities that must be undertaken and completed in order to accomplish their objectives for the entity. Once the budget has been put in place, it serves as a basis for evaluating management accomplishments.

Some additional value of the budgeting process is that it encourages, and in fact requires, careful study, research, and focus on the future. The study and research should not just be looking deeply at the organization itself, but also the market and the environment in which the business intends to compete.

A benefit of this is that it helps management put in place a process of thorough study and research when making decisions. The chance to step back from the daily pressures of running a business to think strategically about the business is perhaps the greatest benefit of the budgeting process to management.

A word of warning here: there is a point where no degree of additional analysis and research will provide additional value. In economic terms, management and analysts developing the budget should recognize this point of diminishing returns, stop thinking and starting acting. Three additional benefits from the budgeting process include providing motivation, coordination of business activities, and communicating plans and instructions.

Because the budget is the standard against which performance will be measured, the manner in which it is used can significantly affect the attitudes of those in the organization that are charged with implementing the budget and are measured against the successful implementation. Management needs to exercise care in developing and communicating the plans and targets of the budget. Plans and objectives need to be realistic, although ‘stretch budgets’, when communicated as such can provide positive motivation.

When a business becomes large enough to be divided into several departments, a critical management task is to ensure that the different segments of the business contribute to the overall goals of the organization. This usually requires coordination between these different groups. The budget helps to provide this coordination.

As an example, the production department’s budget will include producing approximately the number of units that the sales organization is budgeted to sell to meet the company’s overall revenue objective. The purchasing department’s budget includes purchasing enough components and raw materials to enable to production department to meet their production targets.

Some additional considerations that need to be included in the budgeting process are those things that help develop the infrastructure of the organization. Those activities, such as development of the employee base (i.e. continuing education) need to be included in the budget. Additionally, the different parts of the organization, such as marketing, human resources, accounting and finance also play a critical role in the development of the budget. We have mentioned earlier that the production department’s budget includes producing enough products for the sales department to sell. Part of the budgeting process should also include capturing the costs associated with the labor component, existing and required headcount additions, to successfully meet this objective. The communication required between the production manager and the human resources manager is facilitated through the budgeting process and the budget throughout the year.

The true value of the budgeting process, ultimately, is that it provides a tool to unite the entire organization into a cohesive team. This team spends some quality time thinking about the organization and the future prospects and objectives. Collectively, they design the future that the company should take and work together to make it happen. Finally, they use this tool to communicate measure and reward the organization as they achieve the desired objectives and strategies.

- Bob McCarty
  AIRISGroup, Inc.

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