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Part 1. Budgeting: Planning for Success

1. Importance of Budgets

In beginning to write this chapter, I tried to find words to "sugar coat" the title. Perhaps the word "budget" could be avoided altogether. Words like "financial map" or "operational guide" might be suitable alternatives. After all, for those of you already in the workforce, you probably associate the word "budget" with "dread" or "drudgery" or some other less than flattering term. 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 the rather dismal introductory 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. Budgets don't guarantee success, but they certainly help to avoid failure.

1.1. Forms and Functions

Budgets can take many forms and serve many functions. Budgets can provide the basis for detailed sales targets, staffing plans, inventory production, cash investment/borrowing, capital expenditures (for plant assets, etc.), and on and on. Budgets provide benchmarks against which to compare actual results and develop corrective measures. Budgets give managers "preapproval" for execution of spending plans. Budgets allow managers to provide forward looking guidance to investors and creditors. Budgets are necessary to convince 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, etc.). Other types of budgets (e.g., flexible budgets) are covered in subsequent chapters.

1.2. Avoiding Business Chaos

Perhaps the most compelling case for budgeting is to try to imagine an organization without a budget.

In small organizations, formal budgets are actually 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 they have the mental horsepower 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 exigency. 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 businesses, 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. Let's consider a "case study" into the importance of budgeting.

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