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eaffirm their core operating strategy by requiring each business unit to justify its part of the overall
business plan. During the subsequent year, variances of actual results from expectations serve to direct
management to the areas that may deserve a greater allocation of capital and those that may need
adjustments to retain their viability.
A budget is a comprehensive, formal plan, expressed in quantitative terms, describing the expected
operations of an organization over some future time period. As you can see, the characteristics of a
budget are that it deals with a specific entity, covers a specific future time period, and is expressed in
quantitative terms.
This chapter describes the essential features of a budget and includes a comprehensive example of
the preparation of a monthly budget for a small business. Although the focus of the chapter is on
budgeting from a business perspective, many of the principles can be applied to an individual‟s
personal financial planning.
Functions of Budgeting
Planning and control are the two basic functions of budgeting. Planning encompasses the entire
process of preparing the budget, from initial strategic direction through preparation of expected
financial results. Planning is the process that most people think of when the term budgeting is
mentioned. The majority of the time and effort devoted to budgeting is expended in the planning stage.
Careful planning provides the framework for the second function of budgeting, control.
Control is the comparison of actual results with budgeted data, evaluation of the differences, and
then the taking of corrective actions when necessary. The comparison of budget and actual data can
occur only after a period is over and actual accounting data are available. For example, April
manufacturing cost data are necessary to compare with the April production budget to measure the
difference between planned and actual results for the month of April. The comparison of actual results
with budget expectations is called performance reporting. The budget acts as a gauge against which
managers compare actual financial results.
Reasons for Budgeting
Budgeting is a time-consuming and costly process. Managers and employees are asked to contribute
information and time in preparing the budget and in responding to performance reports and other
control-phase budgeting activities. Is it all worth it? Do firms get their money‟s worth from their
budgeting systems?
The answer to those questions cannot be generalized for all firms. Some firms receive far more
value than others do for the dollars they spend on budgeting. Budgets do, however, provide a wealth
of value for many firms that effectively operate their budgeting systems. I now discuss some of the
reasons for investing in formal budgeting systems. In the next section of this chapter I discuss issues
that contribute to effective budgeting.