- Define and explain the terms "profit
planning" and "budgeting".
- What is the difference between planning
- What are the advantages and
disadvantages of budgeting?
and Explanation of Profit Planning and Budgeting
Planning and Control
and Disadvantages of Budgeting
Profit planning can be defined as the set of steps that are taken by firms to
achieve the desired level of profit. Planning is accomplished through the preparation of a
number of budgets, which, when brought through, from an integrated business plan
master budget. The
master budget is an essential
that communicates management's plan throughout the organization, allocates
resources, and coordinates activities.
A budget is a detailed plan for acquiring and using financial and other
resources over a specified period of time. It represents a plan for the future
expressed in formal quantitative terms. The act of preparing a budget is called
budgeting. The use of budgeting to control a firm's activities is called
Master budget is a summary of a company's plan that sets
specific targets for sales, production, distribution, and financing activities.
It generally culminates in
cash budget, a
budgeted income statement, and a
balance sheet. In short, it represents a comprehensive expression of
management's plans for the future and how these plans are to be accomplished.
The term planning and control are often
confused, and occasionally these terms are used in such a way as to suggest that
they mean the same thing. Actually, planning and control are two quite different
concepts. Planning involves developing objects and preparing various budgets to achieve
Control involves the steps taken by management to increase the likelihood
that the objectives set down at the planning stage are attained and that all
parts of the organization are working together toward that goal. To be
completely effective, a good budgeting system must provide for both planning a
control. Good planning without control is time wasting.
Companies realize many advantages / Benefits from a budgeting program. Among these
benefits are the following:
- Budgets provide a means of communicating management's plans through the
- Budgets force
managers to think about and plan for the future. In the
absence of the necessity to prepare a budget, many mangers would spend all of
their time dealing with daily emergencies.
- The budgeting process provides a means of allocating resources to those
parts of the organization where they can be used most effectively
- The budgeting process can uncover many potential
before they occur .
- Budgets coordinates the activities of the entire organization by
integrating the plans of the various parts of the organization. Budgeting
helps to ensure that everyone in the organization is pulling in the same
- Budgets provide goals and objectives that can serve as
evaluating subsequent performance.
Disadvantages / Limitations of Budgeting:
Whilst budgets may be an essential part of
any marketing activity they do have a number of disadvantages, particularly
in perception terms.
Budgets can be seen as pressure devices
imposed by management, thus resulting in:
a) bad labor relations
b) inaccurate record-keeping.
Departmental conflict arises due to:
a) disputes over resource allocation
b) departments blaming each other if targets are not attained.
It is difficult to reconcile
personal/individual and corporate goals.
Waste may arise as
managers adopt the view,
"we had better spend it or we will lose it". This is often coupled with
"empire building" in order to enhance the prestige of a department.
Responsibility versus controlling, i.e.
some costs are under the influence of more than one person, e.g. power
Managers may overestimate costs so that
they will not be blamed in the future should they overspend.
| Bringing Order Out of Chaos:
Consider the following situation
encountered by one of the authors at a mortgage banking firm: For years,
the company operated with virtually no system of budgets whatever.
Management contented that budgeting was not well suited to the firm's
type of operation. Moreover, management pointed out that the firm was
already profitable. Indeed, outward the company gave every appearance of
being a well managed, smoothly operating organization. A careful look
within, however, disclosed that day to day operation were far from
smooth, and often approached chaos. The average day was nothing more
than an exercise in putting out one brush fire after another. The cash
account was always at crisis levels. At the end of a day, no one ever
knew whether enough cash would be available the next day to cover
required loan closings. Departments were uncoordinated, and it was not
uncommon to find that one department was pursuing a course that
conflicted with the course pursued by another department. Employee
morale was low, and turnover was high. Employees complained bitterly
that when a job was well done, nobody ever knew about it.
The company was bought out by a
new group of stockholders who required that an integrated budgeting
system be established to control operations. Within one year's time,
significant changes were evident. Brush fires were rare. Careful
planning virtually eliminated the problems that had been experienced
with cash, and departmental efforts were coordinated and directed toward
predetermined overall company goals. Although the employees were wary of
the new budgeting program initially, they became" converted" when they
saw the positive effects that it brought about. The more efficient
operations caused profits to jump dramatically. Communication increased
throughout the organization. When a job was well done, every body was
knew about it. As one employee stated," For the first time, we know what
the company expects of us"
The concept of
responsibility accounting is very important in profit
planning. The basic idea behind responsibility accounting is that a manager should be
responsible for those items that the managers can actually control to a
significant extent. Each line item (i.e., revenue or cost) in the budget is made
the responsibility of a manager, and that manager is held responsible for
subsequent deviations between budgeted goals and actual results. Someone
must be held responsible for each cost or else no one will be responsible, and
the cost will inevitably grow out of control.
Being held responsible for costs does not mean that the manager is penalized
if the actual results do not measure up to the budgeted goals. However, the
manager should take the initiative to correct any unfavorable discrepancies,
should understand the source of significant favorable or unfavorable
discrepancies, and should be prepared to explain the reasons for discrepancies
to higher management. The point of an effective responsibility system is to make
sure that nothing "falls through the cracks" that the organization reacts
quickly and appropriately to deviations from its plans, and that the
organization learns from the feedback it gets by comparing budgeted goals to
actual results. The point is not to penalize individuals for missing targets.
| A Little
Budgeting plays and important role in
coordinating activities in large organizations. Jerome York, the chief
financial officer at IBM, discovered at one budget meeting that "the
division that makes As/400 workstations planned to churn out 10,000 more
machines than the marketing division was promising to sell. He asked
nicely that the two divisions agree on how many they would sell for the
sake of consistency (and to cut down on the inventory problem). The
rival executives said it could not be done. Mr. York got tougher, saying
it could. Ultimately, it was."
Source: Laurie Hays, "Blue Blood:
IBM's finance chief, Ax in Hand, Scours Empire for Costs to Cut," The
wall Street Journal, January 26, 1994, pp. A1, A6
Operating budgets ordinarily cover one year period corresponding to the
company's fiscal year. Many companies divide their budget year into four
quarters. The first quarter is then divided into months, and normally budgets
are developed. These near term figures can often be established with
considerable accuracy. The last three quarters may be carried in the budget at
quarterly totals only. As the year progress, the figures of the second quarter
is broken down into monthly amounts, then the third quarter figures are broken
down, and so forth. This approach has the advantage of requiring periodic review
and reappraisal of budget data through out the year.
Continuous or perpetual budgets are used by a significant
number of organizations. A continuous or perpetual budget is a 12 month budget
that rolls forward one month (or quarter) as the current month (or quarter) is
completed. In other words, one month (or quarter) is added to the end of the
budget as each month (or quarter) comes to a close. This approach keeps managers
focus at least one year ahead. This approach keeps managers focused on the
future at least one year ahead. Advocates of continuous budgets argue that with
this approach there is less danger that managers will become too narrowly
focused on short-term results.