Budgeting is the process of identifying, gathering, summarizing, and

communicating
financial
and
nonfinancial
information
about
an
organization’s future activities. It is an essential part of the continuous is the
process of identifying, gathering, summarizing, and planning that an
organization must do to accomplish its long-term goals and intermediate
objectives
Careful planning is vital to the health of any organization. Failure to plan,
either
formally
or informally, can lead to financial disaster. Managers of businesses, whether
small
or
large, must know their resource capabilities and have a plan that details the
use
of
these
resources.
Budgeting plays a crucial role in planning and control. Plans identify
objectives
and
the
actions needed to achieve them. Budgets are the quantitative expressions
of
these
plans,
stated in either physical or financial terms or both. When used for planning, a
budget
is a method for translating the goals and strategies of an organization into
operational
terms. Budgets can also be used in control. Control is the process of setting
standards,
receiving feedback on actual performance, and taking corrective action
whenever
actual
performance deviates significantly from planned performance. Thus, budgets
can
be
used
to compare actual outcomes with planned outcomes, and they can steer
operations
back
on course, if necessary.
Advantages of Budgeting
Organizations realize many benefits from budgeting, including:
 Budgets communicate management’s plans throughout the organization.
 Budgets force managers to think about and plan for the future. In the
absence
of
the
necessity to prepare a budget, many managers would spend all of their
time dealing with day-to-day emergencies.

 The budgeting process can uncover potential bottlenecks before they occur. A budget is a financial plan of the resources needed to carry out tasks and meet financial goals Types of Budgets The master budget is a comprehensive financial plan for the year and is made up of various individual departmental and activity budgets. The .  Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. and finished goods inventories. The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively. production.  Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance. Operating budgets are concerned with the income generating activities of a firm: sales. A master budget can be divided into operating and financial budgets. Budgeting helps to ensure that everyone in the organization is pulling in the same direction.

The yearly budgets are broken down into quarterly and monthly budgets.ultimate outcome of the operating budgets is a pro forma or budgeted income statement.” In effect. or pro forma. the pro forma income statement is done “according to form” but with estimated. Planned cash inflows and outflows are detailed in a cash budget. problems are less likely to become too serious. data. . Financial budgets are concerned with the inflows and outflows of cash and with financial position. The use of shorter time periods allows managers to compare actual data with budgeted data as the year unfolds and to make timely corrections. and expected financial position at the end of the budget period is shown in a budgeted. Because progress can be checked more frequently with monthly budgets. balance sheet The master budget is usually prepared for a one-year period corresponding to the company’s fiscal year. not historical. Note that “pro forma” is synonymous with “budgeted” and “estimated.

As a month expires in the budget. an additional month in the future .Most organizations prepare the budget for the coming year during the last four or five months of the current year. A continuous (or rolling) budget is a moving 12-month budget. some organizations have developed a continuous budgeting philosophy. However.

These factors keep costs low and make Southwest a price leader. Strategic planning Companies generally start the strategic planning process by stating their critical success factors. For example. Such broad goals indicate management’s philosophy about the company. airlines. and develop particular markets . Because the long-range plans look into the intermediate and distant future.is added so that the company always has a 12-month plan on hand.S. has efficient gate turnaround.  The strategic long-range profit plan: Although a statement of goals is necessary to guide an organization. For example. value. Strategic plans discuss the major capital investments required to maintain present facilities. they are usually stated in rather broad terms. McDonald’s has developed expertise in the fast-food business over many years. Companies build on these critical success factors to expand operations. increase capacity. It uses a point-topoint network of routes instead of the hub and-spoke system used by most U. name recognition. Proponents of continuous budgeting maintain that it forces managers to plan ahead constantly. diversify products and/or processes. McDonald’s management has realized that its expertise and worldwide reputation could be used to successfully expand throughout the world. and consistency) to succeed in areas outside the United States. and uses only one type of plane.. The company continues to use its competitive advantages (e. These steps are expressed in a strategic long-range plan. it is important to detail the specific steps required to achieve them.g. which are the most important things for the company to do to be successful. A master budget is part of an overall organization plan for the next year. made up of three components:  Organizational goals: are the broad objectives management establishes and company employees work to achieve. Southwest Airlines relies on several factors to maintain its competitive edge.

production and cost levels. But it also has some benefits. and cash flows anticipated for the coming year. For example. affect managers’ beliefs about the coming period. including their personal goals and values. In addition. income. Employees who believe . They might request more money than they need because they expect their request to be cut. Some studies have shown that employees provide inaccurate data when asked to give budget estimates. but market researchers are usually better able to identify long-run market trends and make macro forecasts of sales. The master budget is also known as the static budget. it enhances employee motivation and acceptance of goals. The master budget (tactical short-range profit plan): Long-range plans are achieved in year-by-year steps. The income statement portion of the master budget is often called the profit plan. Although budgets are often viewed in purely quantitative. plans. decision making. and employee performance evaluation.and middle-management employees is often called participative budgeting or grassroots budgeting. People’s forecasts are likely to be greatly influenced by their experiences with various segments of the company. The guidance is more specific for the coming year than it is for more distant years. these budget data are used to construct a budgeted statement of financial position (balance sheet) Budgeting is a dynamic process that ties together goals. district sales managers are in an excellent position to project customer orders over the next several months. and it provides information that enables employees to associate rewards and penalties with performance. the budget plan. technical terms. or the planning budget. the importance of this human factor cannot be overemphasized Budget preparation rests on human estimates of an unknown future. The plan for the coming year is called the master budget. It has an obvious cost. The Human Element in Budgeting A number of factors. but managers do not. The master budget indicates the sales levels. Participative budgeting can also yield information that employees know. it is time consuming. The use of inputs from lower.

Frequent performance reports can reinforce positive behavior and give managers the time and opportunity to adapt to changing conditions. This process is called management by exception Monetary and Nonmonetary Incentives A sound budgetary system encourages goal-congruent behavior. Incentives can be either negative or positive. monetary and nonmonetary incentives. positive incentives use rewards. Negative incentives use fear of punishment to motivate. timely performance reports allows them to know how successful their efforts have been and gives them time to take corrective actions and change plans as necessary. Incentives are the means that are used to encourage managers to work toward achieving the organization’s goals. realistic standards. participation. and multiple measures of performance.that the budget will be used as a standard for evaluating their performance may provide an estimate that will not be too hard to achieve Characteristics of a Good Budgetary System An ideal budgetary system is one that achieves complete goal congruence and simultaneously creates a drive in managers to achieve the organization’s goals in an ethical manner. Frequent Feedback on Performance Managers need to know how they are doing as the year unfolds. These features include frequent feedback on performance. research and practice have identified some key features that promote a reasonable degree of positive behavior. Providing them with frequent. Both . While an ideal budgetary system probably does not exist. Selective investigation of significant variances allows managers to focus only on areas that need attention. controllability of costs. The use of flexible budgets allows management to see if actual costs and revenues are in accord with budgeted amounts.

who helps develop a budget that will accomplish these objectives. resulting in greater goal congruence. what is likely to happen in the forthcoming period. overall objectives are communicated to the manager. In participative budgeting. The advantages of participative budgeting are as follows:    Improved quality of forecasts to use as the basis for the budget: Managers who are doing a job on a day-to-day basis are likely to have a better idea of what is achievable. Typically. participative budgeting allows subordinate managers considerable say in how the budgets are established. participative budgeting has the advantage of involving individuals whose knowledge of local conditions may enhance the entire planning process. Since the subordinate manager creates the budget. Participative mentioned: budgeting has two potential problems that should be 1. Building slack into the budget (often referred to as padding the budget) . etc. rather than one that has been imposed on them from above. not on individual budget items Participative budgeting communicates a sense of responsibility to subordinate managers and fosters creativity. the emphasis is on the accomplishment of the broad objectives. it is more likely that the budget’s goals will become the manager’s personal goals. In addition to the behavioral benefits. can be used by an Participative Budgeting Rather than imposing budgets on subordinate managers. local trading conditions. Improved motivation: Budget holders are more likely to want to work to achieve a budget that they have been involved in setting themselves. Better results: being the executor of the budget the applicant can control the costs better than any other manager.incentives organization.

Padding the budget also unnecessarily ties up resources that might be used more productively elsewhere. and new product development. In the short run. Pseudo participation The first problem with participative budgeting is the opportunity for managers to build slack into the budget. . Budgetary slack exists when a manager deliberately underestimates revenues or overestimates costs. and capable employees will leave for more attractive opportunities. There are numerous examples of myopic behavior. but in the long run. organizations make the mistake of using budgets as their only measure of managerial performance. Either approach increases the likelihood that the manager will achieve the budget and consequently reduces the risk that the manager faces. advertising. Multiple Measures of Performance Often. Overemphasis on this measure can lead to a form of dysfunctional behavior called milking the firm or myopia. seeking only superficial participation from lower-level managers.2. these actions will lead to improved budgetary performance. Top management is simply obtaining formal acceptance of the budget from subordinate managers. Accordingly. market share will decline. productivity will fall. not seeking real input. managers can reduce expenditures for preventive maintenance. none of the behavioral benefits of participation will be realized. To meet budgeted cost objectives or profits. Managers can also fail to promote deserving employees to keep the cost of labor low and can choose to use lower-quality materials to reduce the cost of materials. This practice is termed pseudo participation. The second problem with participation occurs when top management assumes total control of the budgeting process. Myopic behavior occurs when a manager takes actions that improve budgetary performance in the short run but bring long-run harm to the firm.

but overemphasis on them can be counterproductive. Productivity.The best way to prevent myopic behavior is to measure the performance of managers on several dimensions. Financial measures of performance are important. . and personnel development are examples of other areas of performance that could be evaluated. quality. including some long-run attributes.