In many companies, the budget process starts with top management communicating goals and economic assumptions for the upcoming year down the chain of command in the organization. Division or departmental managers are given the responsibility of preparing budgets based on these assumptions. Usually the finance department consolidates the individual budgets into one for the company as a whole. From there, top management and the managers reporting to them discuss adjustments to the final budgets, which sometimes include cuts.
Efficient Resource Allocation
The budget describes the resources -- human, financial, production capacity and productivity tools required to accomplish the company's objectives for the upcoming year. If this resource allocation process is done properly, everyone within the organization has the tools and resources they need to accomplish the goals set for them. Finalizing the budget involves identifying any gaps or necessary expenditures that have been left out.
Making Sure the Budget is Lean
Department managers sometimes pad their budgets. From prior experience, they know that top management is likely to make cuts in their final budget, so they submit a request for more than they need. Before finalizing the budget, top management must ensure that all the proposed expenditure increases are justified. This involves meetings among the divisional managers, top managers and the finance department where managers are asked to provide additional information about why the expenditures are necessary.
Furthers Long-Term Objectives
Companies have a tendency to prepare a budget that focuses just on what needs to be accomplished in the upcoming year. But the long-term growth of the company depends upon funding projects that have no impact on next year's revenues or earnings. Companies deal with this problem by preparing a long-range strategic plan for the next three to five years at the same time they are preparing the budget. In this way, before the budget is finalized top management can make sure that funding for future needs is included.
In the finalized budget, the projected revenues and profits should be reasonable and attainable, reflecting the reality of the company's business environment and not just the hopes of the management team. Overly optimistic forecasts can cause problems when actual results show the company missing its revenue targets by a wide margin. This can result in serious cash shortfalls that will force the company to make difficult choices about budgetary items to cut in order to narrow the gap between budget and actual results in the upcoming months.
Top management should strive to maintain fairness to all departments or divisions as they make the difficult decisions about what items to cut -- or add. No one should be given preferential treatment and no one should be shortchanged.
Once the budget is finalized everyone in the organization has to pull together to achieve the company's goals. To ensure this cooperation, managers need to understand the reasons for the final budgetary decisions that were made by top management. Top management should take the time to meet with department heads and discuss the reasons for their decisions. They should solicit feedback from the department managers and have a true dialogue about any issues that may cause resentment down the line. If the budgetary decisions seem unreasonable, managers may not be as motivated as top management would like.
- "Financial Management 101: Get a Grip on Your Business Numbers"; Angie Mohr; 2007
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