The role of budgeting in planning and control

Budgeting plays a crucial role in planning and control. Plans identify objectives and the actions needed to achieve them. Budgets are the quantitative expressions of these plans, stated in either physical or financial terms or both. When used for planning, a budget is a method for translating the goals and strategies of an organization into operational terms. Budgets can also be used in control. Control is the process of setting standards, receiving feedback on actual performance, and taking corrective action whenever actual performance deviates significantly from planned performance. Thus, budgets can be used to compare actual outcomes with planned outcomes, and they can steer operations back on course, if necessary. Exhibit 8-1 illustrates the relationship of budgets to planning, operating, and control. Budgets evolve from the long-run objectives of the firm; they form the basis for operations. Actual results are compared with budgeted amounts through control. This comparison provides feedback both for operations and for future budgets.

Also read the budgeting process
Purposes of Budgeting
Budgets are usually prepared for areas within an organization (departments, plants, divisions, and so on) and for activities (sales, production, research, and so on). This system of budgets serves as the comprehensive financial plan for the organization as awhole and gives an organization several advantages.

1.  It forces managers to plan.
2.  It provides resource information that can be used to improve decision making
3. . It aids in the use of resources and employees by setting a benchmark that can be used for the subsequent evaluation of performance
4.  It improves communication and coordination.

Budgeting forces management to plan for the future to develop an overall direction for the organization, foresee problems, and develop future policies. When managers plan, they grow to understand the capabilities of their businesses and where the resources of the business should be used. All businesses and not-for-profit entities should budget. All large businesses do budget. In fact, the budgeting activity of a company such as Conoco or IBM consumes significant amounts of time and involves many managers at a variety of levels. Some small businesses do not budget, and many of those go out of business in short order.

Budgets enable managers to make better decisions. For example, a cash budget points out potential shortfalls. If a company foresees a cash deficiency, it may want to improve accounts receivable collection or postpone plans to purchase new assets. Budgets set standards that can control the use of a company’s resources and control and motivate employees. Fundamental to the overall success of a budgetary system, control ensures that steps are being taken to achieve the objectives outlined in an organization’s  master plan.

Budgets also serve to communicate the plans of the organization to each employee and to coordinate their efforts. Accordingly, all employees can be aware of their role in achieving those objectives. This is why explicitly linking the budget to the long-run plans of the organization is so important. The budget is not a series of vague, rosy scenarios, but a set of specific plans to achieve those objectives. Budgets encourage coordination because the various areas and activities of the organization must all work together to achieve the stated objectives. The role of communication and coordination becomes more important as an organization increases in size.

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