Cheri Standish, the controller at Harmonics International, overheard the followi

Question

Cheri Standish, the controller at Harmonics International, overheard the following conversation among two of her product line department heads, Bob, manager of Pianos and Keyboards, and Fran, manager of Horns and Stringed Instruments. Fran: “This budgeting process is consuming an inordinate amount of time. Each time I prepare a budget and send it to the controller’s office, it comes back for revision. This is the third time I have had to reallocate funds for my budget requests. Bob: “I know what you mean. And because we are evaluated on our ability to stay in budget, it is critical to have a cushion in case the economy turns south and sales of musical instruments do not meet projections.” What comments should the controller make to these two department heads about the benefits and the importance of the budgeting process?

Explanation / Answer

Cheri Standish, the controller commented, this should not be followed, because it has many advantages for an organization some of which are:

Budgets are a financial road map.

A budget helps an organization decipher how to get from here to there, while outlining the resources required for the journey. henceforth, the budgeting process (i.e., allocating funds to functions) can serve as a powerful planning tool for top management.

Budgets are effective tools of management.

By comparing an organization’s performance to its budget, management can see if they’re on track to meet goals, or if corrections are needed mid-course. Without a budget, it’s nearly impossible to know if changes are needed in key areas such as development and staffing.

Budgets can bolster revenue.

Having concrete numbers in place is essential to securing more revenue through grants or other funding sources. Better “top-line” revenue allows an organization to increase coverage of its mission, while a steady cash flow can help secure loans for capital improvement projects and expansion.

Budgets provide an internal control.

Perhaps the most obvious benefit of a budget is this: It allows an organization to effectively monitor its finances. In doing so, organizations can better guard against fraud and other potentially devastating financial risks. Organizations should prepare budgets on a monthly basis to make tracking-to-budget relevant and accurate throughout the year.

Importance of budgeting:

Clearly Defined Goals

The Financial Goals of the company need to be defined at the beginning of the process. A typical goal would be Revenue Growth at 20%, Net Income Growth of 10% and Departmental Operating Expense Growth at varying growth levels. Typically, depending on the company, each Division/Department has different growth expectations depending on the type of company. Businesses that have significant Research and Development activities, for example, usually allocate a larger amount to R&D expenses. The process of developing the goals begins with an analysis of the current year’s performance and an understanding of what relationships exist to Revenue, fixed and variable.

Effective Communication

In order for the Management Team to be able to translate the Goals into an Operating Budget, effective communication is imperative. First, a timetable needs to be developed to set expectations and to determine deadlines. A company meeting to communicate the process is desirable to ensure everyone receives the same message.

Management Involvement

For the process to be effective, Management buy-in is essential both in the planning process and during the year to monitor and manage actual performance. One purpose of the budgeting exercise is to achieve consensus by everyone even though they are all competing for the same resources. It is not possible for everyone to be able to add all the headcount they desire or spend the amount of money they would prefer. In addition, each department has a different perspective on what is necessary to achieve the company’s goals and the importance of their contribution. By the end of the process, everyone will have had to compromise and should understand where their interests all intersect with the company’s goals.

Coordination

Someone needs to be in charge of the process and drive towards the deadlines. It is common for it to fall within the Chief Financial Officer’s responsibilities. Absent that position, at the direction of the COO it usually belongs in the Controller’s responsibilities. Preparing the information for goal setting, creating the worksheets, consolidating the information and being available to facilitate the process are all responsibilities of this position.

Actual Performance Reporting

Important to the effectiveness of the process is regular comparison of actual performance to the budget. In addition to the inclusion of budgets in the financial statement comparisons, many decisions should be made with the budget in mind. For example, headcount additions and fixed asset acquisitions should be evaluated if they were not budgeted expenses. Many companies allow expenditures that were approved in the budget process but require extensive justification if they were not.

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