174 Understanding the Numbers
FUNCTIONS OF BUDGETING
The two basic functions of budgeting are planning and control. Planningen-
compasses the entire process of preparing the budget, from initial strategic di-
rection through preparation of expected financial results. Planning is the
process that most people think of when the term budgetingis mentioned. Most
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.
Controlinvolves comparing actual results with budgeted data, evaluating
the differences, and taking corrective actions when necessary. The comparison
of budget and actual data can occur only after the period is over and actual ac-
counting data are available. For example, April manufacturing cost data are
necessary to compare with the April production budget to measure the differ-
ence between planned and actual results for the month of April. The compari-
son 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 re-
sponding 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 other firms for the dollars they spend on
budgeting. Budgets do, however, provide a wealth of value for many firms who
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.
Budgets offer a variety of benefits to organizations. Some common bene-
fits of budgeting include the following:
- Requires per iodic planning.
- Fosters coordination, cooperation, and communication.
- Forces quantification of proposals.
- Provides a framework for performance evaluation.
- Creates an awareness of business costs.
- Satisfies legal and contractual requirements.
- Orients a firm’s activities toward organizational goals.