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I'm Larry Walther.
This is principlesofaccounting.com, Chapter 21, on budgets.
And, in this first module, we will consider the importance and
use of budgets within an organization.
Now, recognize that many times employees view budgets as tedious,
unnecessary, a painful process.
In other words, if they feel like they're selling all they can,
working as hard as they can, being efficient as they can with
the company resources, what's the point of budgeting?
It serves no purpose.
So I say sometimes budgets are seen as painful.
They're seen as imposing constraints in establishing goals that
can also be hard to meet.
However, when you think further, you need to recognize how imperative it is that
an organization carefully plan their affairs to achieve financial success.
So a formal definition of a budget simply is that a budget is a detailed
financial plan that quantifies future expectations and
actions relative to acquiring and using resources.
It's a fairly deep definition.
Looking closely, a detailed financial plan quantifying expectations and
actions relative to acquiring and using resources.
It defines the pathway to the future for the organization.
In a small organization, formal budgets are actually quite rare.
The owner or manager might actually maintain a mental budget in their mind.
They know a lot about the business, what they seek to achieve,
what the available resource pool is with regard to that, and
what the constraints facing the organization are.
When things don't go well, the owner or manager can usually adapt on the fly.
They can take up the slack by not taking a paycheck or engaging in some other
rapidly adapting strategy to react to changing circumstances.
That's a little harder to do, obviously, in a large organization.
Many small businesses ultimately fail,
however, because they fail to plan, they're under capitalized or
have insufficient resources to sustain operations.
If you talk to people who have had business failures,
small business failures, at the end of the day,
I think they realize some of the mistakes they made could have been anticipated.
They wish they had planned better, they had done some formal financial planning
in advance of even going into the business.
It can reveal business plans that are not practical, unachievable, and
also identify areas of risk that can be planned to be avoided.
Therefore, without a budget, an organization can become ineffective and
inefficient.
Let's think about this in the context of a case study.
This is exactly the case study that's talked about in your textbook.
And I said,
just imagine you're the manager of a newly constructed power plant.
And you tend to think about marketing and personnel management,
issues of that nature, feeling that those are the value drivers for the business.
Perhaps those efforts do, indeed, sell a lot of electricity.
But recognize that sales growth could be so strong that you don’t have enough
natural gas supply to fuel the power plant to deliver the customers' demands.
And, therefore, you have to result to an urgent purchase of maybe some kind of fuel
oil that’s more expensive and that has to trucked in at great cost.
That can cause the business to not be profitable.
The suppliers of your fuel sources can become concerned about your financial
ability to continue to operate.
They may apply tightened credit terms that further exacerbate the credit
crunch the company is facing.
They may find it necessary to reduce the workforce.
And so, overall, simply the failure to plan, and
performance in terms of sales, has caused an unanticipated problem.
Normally, you think of those increased sales as driving success, not failure.
Now, a good plan would have prevented this from happening.
With a plan, studies would have been performed to determine the most efficient
levels of operation.
Those expected sales could be translated into a schedule of expected delivery of
electricity.
Long-term contracts could be negotiated for the necessary supplies.
Staffing plans would be developed that optimize efficiency within
the organization.
Contingency plans can be put in place for unexpected scenarios.
And, indeed, a line of credit could be established in advance with a bank,
based upon the budgeted outcomes, so
that you wouldn't have a credit crunch at any particular point in time.
That paints an entirely different picture, it points to the need or necessity for
proper financial planning.
It's important that individuals act consistent with the plan.
A plan gives a goal or
an operational strategy that the entire team can work toward.
It gives a tool for the manager to monitor operations and
take corrective actions when there are deviations from the plan.
There are many benefits from budgeting, specifically, they
translates general plans into specific action-oriented goals and objectives.
They provide a mechanism for identifying and
focusing departments on particular plans.
And they also introduce the concept of responsibility accounting.
This simply means that units and managers are held accountable for
transactions under their direct control and influence.
This causes responsibility to be pushed down to a personal level,
rather than simply saying, well, the organization failed.
We don't know who's responsible for what in the failure.
It gives us a way to key in on areas that need improvement.
It aids managers in backing overall plans that maximize results for
the entire entity.
It also identifies constraints and bottlenecks within the organization.
So, in closing, what I would suggest is,
despite the perception that budgets are perhaps unnecessary or a painful or
a tedious process, what I would like you to think about is the necessity of those
in managing an organization to scale and proper operational efficiency.
As you go forward in this chapter and look at additional modules, be sure and
keep in mind, some of it becomes rather mechanically tedious, spreadsheets and
data movement, keep in mind, don't forget, in other words,
the organizational objective for the whole budgeting process.
It's necessary for
business success.
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