1.3 The budget process and its objectives
Managers have a responsibility for achieving the objectives of the operation. Operational objectives are usually derived from the strategic plans, or more often in larger organisations the business plan.
The strategic plan of an organisation will set out the overall direction and goals of the business. Such a plan helps the organisation to define the type of business, or businesses, it is in and states the long term goals of the organisation. Long term goals are usually no more than 3 years in the constantly changing modern business environment. Once long term objectives are decided upon they are broken down into one-year elements in order to provide a short-term, tactical framework for the organisation's overall or operational budget(s).
The management team is usually responsible for the preparation of budgets and the responsibility for specialist areas is delegated to the appropriate manager or specialist in that operational area or team. These areas may include sales, marketing, human resources, production and purchasing. In other words, any operational area that is seen as essential to achieving the organisational objectives will have a specific budget. The number of budgets prepared within an organisation will depend on the type of industry, size of the business and the specific needs of management.
The accounting system of the operation provides information on what has happened in the past and helps mangers to keep track of whether or not they are meeting their current budgets. Managers require information not only from the past, however, they also need to use financial information to provide expectations for the future. Budgets are therefore an expectation of what a manager agrees is achievable within the immediate future and are mostly expressed in financial terms.
The absence of a strategic plan or targets set by senior management often leads to more informal goal setting by business owners or managers. These types of plans usually rely on the use of business history and past performances to predict the future in a more ad hoc manner. The disadvantage of this method for financial planning is that other people do not have a clear direction of where the organisation is heading and what they are expected to do to meet the organisations objectives. This method also uses information that is based more on intuition than hard data and may not lead to an accurate understanding of the financial position of the organisation.
Activity 3
Complete the following alone or in collaboration with some colleagues.
- Create a list of the types of budgets that operate within your organisation. Conduct a discussion with members of your study group or a work colleague to gain and share an understanding of the budgets that you identify.
Reading/Case Study 1
Creek Clothing Company is a family owned manufacturing business that specialises in the manufacture of men's shirts. The demand for their products is seasonal, however, as the Creek range is geared mostly towards summer wear and winter sales are low.
The Creek factory is able to plan production throughout the calendar year as there is a delay in time between the production of the shirts and the sale of items to distributors and retailers.
Creek Clothing Company does not produce budgets and have relied on the strict control of sales, forward orders and cash on hand. It has been necessary for the company to borrow money from the bank in the past, as inventory and stock has built up, tying up their cash on hand.
Although budgets have not been produced in the business before, the managers and owners compare actual performance in any year with that of the previous year, to give them an indication of current performance.
The company accountant has persuaded Creek Clothing Company to consider budgeting. She has suggested that the best starting point is to produce an expectation of profits that includes sales and the cost of production. The budget is to include all operating costs and overheads, including tax. The budget should also show a surplus of income over expenditure, indicating a net profit.
Creek Clothing Company has decided to create a three-year projection. The company has produced a profit budget for the next three years (this is displayed below). This is new ground for the Creek Clothing Company and all agree that the budget gives the business some expectation as to what the owners want to happen.
The exercise resulted in the management team and owners coming together to discuss and understand the projection of sales and overheads. The senior managers were involved in the process for the first time and there was opportunity for discussion on what may happen in the future and how they may reduce expenses and increase sales.
Table 3 Creek Clothing Company - Profit Budget July 20XX - June 20XX
PROFIT PROJECTION CREEK CLOTHING Co |
||||
Year |
|
20XX |
20XX |
20XX |
|
|
($000's) |
($000's) |
($000's) |
Sales |
|
5000 |
5500 |
6100 |
Cost of Sales - |
3400 |
3700 |
4000 |
|
Gross Profit = |
2600 |
2800 |
3100 |
|
Overheads - |
1500 |
1600 |
1700 |
|
Net Profit = |
2100 |
2200 |
2400 |
|
Tax - |
|
1440 |
1480 |
1560 |
Profit (after Tax) |
1660 |
1720 |
1840 |
|
Activity 4
After reading the above Creek Clothing Company study/scenario now set Operational Profit Projections by answering the following questions.
- What benefits has the company gained as a result of developing a budget?
- What is the most interesting feature of the budget prepared here?
- What is your opinion of the estimates - do you think they are accurate enough to use?
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