Gabriela (Gaina) I.

Munteanu
AMA (ID)_1- Facultatea de stiinte economiceJanuary 4, 2021

The importance and use of budgets within an organization

Many associate the word “budget” with “dread” or “drudgery.” Perhaps the word
“budget” should be avoided altogether. Words like “financial map” or “operational guide”
might be suitable alternatives. No doubt, some employees will question the need for a budget.
The process of budget preparation is sometimes seen as painful, and it is not always clear how
the effort that is required leads to any productive output. Furthermore, budgets can be seen as
imposing constraints that are hard to live with and establishing goals that are hard to meet!
Despite these dismal remarks, it is imperative that organizations carefully plan their
financial affairs to achieve financial success. These plans are generally expressed as
“budgets.” A budget is a detailed financial plan that quantifies future expectations and actions
relative to acquiring and using resources.

Forms And Functions

Budgets can take many forms and serve many functions, providing the basis for
detailed sales targets, staffing plans, inventory production, cash investment/borrowing, capital
expenditures (for plant assets, etc.), and so on. Budgets provide benchmarks against which to
compare actual results and develop corrective measures; give managers “preapproval” for
execution of spending plans; and allow managers to provide forward-looking guidance to
investors and creditors. Budgets are necessary to persuade banks and other lenders to extend
credit. This chapter will illustrate the master budget, which is a comprehensive set of
documents specifying sales targets, production activities, and financing actions. These
documents lead to forward-looking financial statements (e.g., projected balance sheet). Other
types of budgets (e.g., flexible budgets) are covered in subsequent chapters.
 
Avoiding Business Chaos

In small organizations, formal budgets are a rarity. The individual owner/manager

likely manages only by reference to a general mental budget. The person has a good sense of
expected sales, costs, financing, and asset needs. Each transaction is under direct oversight of
this person and hopefully he or she has the ability to keep things on a logical course. When
things don’t go well, the owner/manager can usually take up the slack by not taking a
paycheck or engaging in some other form of financial hardship. Of course, many small
businesses ultimately fail anyway. Explanations for failure are many and varied, but are often
pinned on “undercapitalization” or “insufficient resources to sustain operations.” Many of
these postmortem assessments reflect a failure to adequately plan! Even in a small business,
an authentic business plan/budget can often result in anticipating and avoiding disastrous
outcomes.
Medium and larger organizations invariably rely on budgets. This is equally true in
business, government, and not-for-profit organizations. The budget provides a formal
quantitative expression of expectations. It is an essential facet of the planning and control
process. Without a budget, an organization will be highly inefficient and ineffective.
 
Budgeting Case Study

Imagine that one has just been appointed as general manager of a newly constructed
power plant. Compensation and ultimately the manager’s job will depend on the financial
success of the venture. The manager would try to quickly get a handle on the business. How

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Gabriela (Gaina) I. Munteanu
AMA (ID)_1- Facultatea de stiinte economiceJanuary 4, 2021

many customers will be served? What are the peak electricity loads? What rate can be charged
and will it be enough to cover expenses? How much fuel will be necessary to produce the
electricity? Will the cash supply always be sufficient to meet needs? Furthermore, how will
actions be executed and controlled?
Perhaps the above is too much to deal with. Instead the manager could spend time only
on marketing and personnel management. These efforts might sell a lot of electricity.
Unfortunately, sales growth could be such that the natural gas pipeline cannot deliver enough
fuel to meet the plant’s demand. More expensive fuel oils might need to be trucked in to
produce the electricity. Suppliers might become concerned, as they sense that revenues might
be inadequate to cover the added fuel cost. As a result, vendors might begin to insist on
shortened payment terms, thereby pressuring the company’s cash supply. To solve this
problem, it could become necessary to reduce the workforce. A downward spiral might ensue.
Rewind this unfortunate scenario, this time utilizing a plan. Careful studies are
performed to determine the most efficient levels of production for the plant, in conjunction
with an assessment of customer demand. The expected sales are translated into a schedule of
expected daily electricity production. Based on this information, long-term supply contracts
are negotiated for natural gas supplies. Staffing plans are developed that optimize the number
of employees and their work times. Contingency plans are developed for a variety of
scenarios. Periods during which cash might be tight are noted and a line of credit is set up
with a local bank to cover those periods. All of these activities lead to a projected outcome.
Once the plan is in place, individuals will be authorized to act consistent with the plan.
The entire team will steer toward an expected outcome. The manager will monitor operations
and take corrective actions for deviations from the plan. The remainder of his time can be
spent on public relations marketing, employee interaction, and so forth.
 
Benefits Of Budgeting

Budgets don’t guarantee success, but they certainly help to avoid failure. The budget is
an essential tool to translate general plans into specific, action-oriented goals and objectives.
By adhering to the budgetary guidelines, the expectation is that the identified goals and
objectives can be fulfilled.
It is crucial to remember that a large organization consists of many people and parts.
These components need to be orchestrated to work together in a cohesive fashion. The budget
is the tool that communicates the expected outcome and provides a detailed script to
coordinate all of the individual parts to work in concert.
When things don’t go as planned, the budget is the tool that provides a mechanism for
identifying and focusing on departures from the plan. The budget provides the benchmarks
against which to judge success or failure in reaching goals and facilitates timely corrective
measures.
Operations and responsibilities are normally divided among different segments and
managers. This introduces the concept of “responsibility accounting.” Under this concept,
units and their managers are held accountable for transactions and events under their direct
influence and control.
Budgets should provide sufficient detail to reflect anticipated revenues and costs for
each unit. This philosophy pushes the budget down to a personal level, and mitigates attempts
to pass blame to others. Without the harsh reality of an enforced system of responsibility, an
organization will quickly become less efficient. Deviations do not always suggest the need for
imposition of penalties. Poor management and bad execution are not the only reasons things
don’t always go according to plan. But, deviations should be examined and unit managers
need to explain/justify them.

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Gabriela (Gaina) I. Munteanu
AMA (ID)_1- Facultatea de stiinte economiceJanuary 4, 2021

Within most organizations it becomes very common for managers to argue and
compete for allocations of limited resources. Each business unit likely has employees
deserving of compensation adjustments, projects needing to be funded, equipment needing to
be replaced, and so forth. This naturally creates strain within an organization, as the sum of
the individual resource requests will usually be greater than the available pool of funds.
Successful managers will learn to make a strong case for the resources needed by their units.
But, successful managers also understand that their individual needs are subservient to
the larger organizational goals. Once the plan for resource allocation is determined, a good
manager will support the overall plan and move ahead to maximize results for the overall
entity. Personal managerial ethics demands loyalty to an ethical organization, and success
requires teamwork. Here, the budget process is the device by which the greater goals are
mutually agreed upon, and the budget reflects the specific strategy that is to be followed in
striving to reach those goals. Without a budget, an organization can be destroyed by constant
bickering about case-by-case resource allocation decisions.
Another advantage of budgets is that they can be instrumental in identifying
constraints and bottlenecks. The earlier example of the power plant well illustrated this point.
Efficient operation of the power plant was limited by the supply of natural gas. A carefully
developed budget will always consider capacity constraints. Managers can learn well in
advance of looming production and distribution bottlenecks. Knowledge of these sorts of
potential problems is the first step to resolving or avoiding them.
 

Source:

Principles of Accounting: https://www.principlesofaccounting.com/chapter-21/

New terms and definitions:

accounting - A set of concepts and techniques that are used to measure and report
financial information about an economic unit
assets - The economic resources owned by an entity; entailing probable future benefits
to the entity
balance sheet - A financial statement that presents a firm's assets, liabilities,
and owners' equity at a particular point in time
expenses - The costs incurred in producing revenues
revenue - Income, especially when of an organization and of a substantial nature.
financial statements - Core financial reports that are prepared to represent the financial
position and results of operations of a company
dismal - causing a mood of gloom or depression
statement - A document setting out items of debit and credit between a bank or other
organization and a customer.
credit - The nature of an action to an account to indicate an increase (liabilities, equity,
and revenue) or decrease (assets, expenses, and dividends); usually right-justified in an entry.
Borrowing - To receive money from another party with the agreement that the money
will be repaid
flexible budget - A budget that covers a range of potential outcomes by relating
expense levels to the potential revenues.
master budget - Also known as the comprehensive budget; an integrated set of
articulated budgets relating to numerous operational subcomponents (labor, material,
overhead, etc.)

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Gabriela (Gaina) I. Munteanu
AMA (ID)_1- Facultatea de stiinte economiceJanuary 4, 2021

Questions:

1. Why is important to plan a budget?

Planning a budget is one of the most essential aspects in any project. A detailed budget
plan will make sure you take all the necessary and important decisions that will help the
project stay on course throughout the duration of the project.
2. What is a budget?
A budget is an estimate of the revenues and expenses of a business over a given period
of time.
3. It is good to have a detailed budget plan?
Yes, because a more detailed budget plan reflects how you will be allocating resources
during the project, where you can raise revenue from in case of a crisis and so on. It also gives
a clear idea about how to use the revenue to achieve all the project goals in the best way
possible.
4. Why is a budget necessary?
A budget is very essential in terms of planning for the future of the project. It covers
aspects that include expenses for marketing, expansion and so on.
5. What can provide a good budget plan?
It can provide a clear idea about the cash flow as you will be able to monitor the
inflow and the outflow of financial resources by comparing the same with your budget.
Planning for a budget will also provide you with a way to procure additional finances through
financial institutions in case there is a shortage.
6. It’s easy to create a budget?
Creating a budget is not an easy task as you may have to look into several different
parameters to make sure that everything has been accounted for.
7. How can you create a budget?
It is always a good idea to revisit some of the previous budgets that you may have
made and use the same as a model. It is also a good idea to do your research and ensure that
you are not missing out on anything.
8. How does budget help?
You may need to know that even though a project fails, the budget plan can provide an
in depth insight into the reasons why a project went awry. You can compare your forecasts

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Gabriela (Gaina) I. Munteanu
AMA (ID)_1- Facultatea de stiinte economiceJanuary 4, 2021

with actual numbers to find out why the forecasts were wrong. This will allow you to reassess
your approach to the project and will help you learn from mistakes.

9. Does budget guarantee success?

The key to a successful budget is consistency. Since budgeting is a long-term process,
the more consistently you log your expenses, assess your progress toward your financial
goals, and look for ways to reduce wasteful spending, the more benefit your budget will have
on your financial life.

10. Which are the benefits of a business budget?

 manage your money effectively.
 allocate appropriate resources to projects.
 monitor performance.
 meet your objectives.
 improve decision-making.

11. What kind of organizations should use budget plan?

All kind of organizations: small, medium or large, they all should rely on budget.

12. Which is the attribute of a good general manager?

Ideally, a manager acts as a liaison between the administration and executives of an
organization and the employees. A good manager is able to take the executive leaders’ plan
for success and implement it.

13. What are the forms of budget?

Four Main Types of Budgets/Budgeting Methods. There are four common types of
budgets that companies use: (1) incremental, (2) activity-based, (3) value proposition, and (4)
zero-based.

14. What is chaos in organization?

Chaos introduces uncertainty, unpredictability, irregularity and randomness in
organizations; and it challenges the conventional leadership theories, models and
philosophies.

15. What functions purposes does the budget serve?

In the context of business management, the purpose of budgeting includes the
following three aspects: A forecast of income and expenditure. A tool for decision making. A
means to monitor business performance.

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Gabriela (Gaina) I. Munteanu
AMA (ID)_1- Facultatea de stiinte economiceJanuary 4, 2021