178 Understanding the Numbers
to resolve difficult issues, but it results in a budgeting framework that is much
more likely to be effective since all business units proceed in a coordinated
manner toward the achievement of a common objective. Even individuals need
to understand their goals and objectives as they prepare budgets for their own
activities.
Realistic Plan
Budgeting is not wishful thinking; it is a process designed to optimize the use of
scarce resources in accordance with the goals of the company. Many firms have
budgets that call for sales growth, higher profits, and improved market share,
but to be effective such plans must be based on specific executable plans and
on available resources and management talent that the company can bring to
bear in meeting the budget. If the management of a firm wants to improve its
level of operations, there must be a clearly defined path between the present
and the future that the firm can travel.
The process begins with an analysis of the market and preparation of a
SWOT (strengths, weaknesses, opportunities, and threats) analysis. Utilizing
this background information, the company develops an overall strategy to-
gether with the operational tactics required to achieve it (the development of a
business plan is discussed further in Chapter 9). The financial impact of this
strategy is then assessed in the preparation of the budget. If the financial re-
sults are unfavorable, strategies and tactics must be revised until an acceptable
outcome is achieved. Once the budget is finalized, strategies are implemented
and the company’s operations are subsequently monitored throughout the year
in the control phase, as discussed next. Exhibit 6.1 presents an iterative model
that embodies these concepts.
Participative Budgeting
Most behavioral experts believe that individuals work harder to achieve objec-
tives that they have had a part in creating. Applied to budgeting, this concept
states that employees will strive harder to achieve performance levels defined
by budgets if the employees have had a part in creating the budget. Budgets
imposed by top-level management, in contrast, may get little support from
employees. The concept of building budgets from the bottom up with input
from all employees and managers affected by the budget is called par ticipative
budgeting.
The Control Phase of Budgeting
The first and most time-consuming phase of budgeting is the planning process.
The control phase of budgeting, however, may be the time when firms get the
most value from their budgeting activities. Exhibit 6.2 is a budget-performance
report for the first quarter of 2001. The difference between budgeted and