Operational budgeting is an important step in the management control process, since it is during this phase that an organization sets out its plans for the upcoming year. Moreover, in many organizations, the budget is used as a central aspect of measuring managerial performance. As a result, operational budgeting has both mechanical and behavioral aspects.

One of the most fundamental problems in budgeting concerns the issue of what, in fact, the budget measures. Indeed, while the budget may be the only concrete measure of a manger’s performance, it usually assesses only one side of a two-sided equation. The other side of the equation— the achievement of longer-run, strategic and programmatic objectives—generally is not measured by the budget, and, some people argue, is not measurable at all. For this reason, the budgetary process frequently is treated quite mechanically in many organizations.

Clearly budgeting has a mechanical aspect. Revenue forecasts must be made, the associated expenses must be estimated, and an overall budgeted surplus or deficit figure must be calculated. For organizations to use the budget as managerial tool, however, they must view it from a more global perspective than just its mechanics. We look first at this more global perspective, and then use the resulting context as a basis for discussing the mechanical side of budgeting. After completing this note, you should know about

• The organizational and strategic contexts in which operational budgeting takes place
• The mechanical aspects of operational budgeting
• The key elements in the budgetary process, and the relationship between budgeting and responsibility centers
• The definition of a budgeting misfit, and seven common budgeting misfits

The Context for Budgeting

Operational budgeting has both a formulation and a monitoring phase. In this note, most of our emphasis is on formulation. Nevertheless, to put operational budgeting in context, we need to look at both phases. Doing so allows us to view budgeting’s mechanical and a behavioral aspects in a strategic context.

The activities that comprise these two aspects are quite different in each of the two phases. Further, the whole process exists in an organizational context that gives it a contingent nature, thereby explaining why different organizations have different budgetary systems. This idea is shown schematically in Exhibit 1. To better understand it, let’s examine some of the key elements, beginning with the organizational context and the budgeting context, and then moving to the budget formulation and monitoring activities.

Organizational Context. One way of thinking above the context for a budget is in terms of the organization’s environment, strategy, and culture.

Environment. In many respects, the organization’s environment governs much of what happens in its budgeting process. If, for example, an organization is operating in a highly regulated environment, such as some hospitals do, its budget process must be geared in part to the needs of the regulatory agencies and the constraints they place on the organization. On the other hand, if an organization operates in a highly competitive environment, it quite likely will need a budgetary process that eliminates as much “slack” as possible. By contrast, an organization that is the sole provider of a particular service may not need to pay as much attention to its costs.

Strategy. An organization’s strategy also will have affect its budgetary process. If we define strategy in terms of the organization’s programs, the markets in which it operates, its sources of financing, and its personnel policies, we can see a great deal of room for strategic differences among organizations that might otherwise appear quite similar. For example, a home health agency, operating in a rural area, focusing on home care services, and using many unskilled laborers quite likely would need a different budgetary process than a home health agency, located in an urban area, focusing on nursing and physical therapy visits, and using highly-trained professionals.

Culture. Finally, an organization’s culture will have an influence on the budget. If, for example, a medical school values a highly collegial atmosphere among its faculty, it likely will have a different budgetary process than a medical school that thinks of its faculty as “hired help.”