As long as there are scarce resources and alternative uses, an organization will face financial constraints. Most organizations deal with this by means of the annual budgeting activity. As contrasted with programming, which looks ahead several years, budgeting generally is for a single year. Ordinarily, it uses the new programs, products, or product lines that emerged from the programming phase, along with existing programs, products, and product lines, and attempts to determine the revenues, expenses, and non-financial outcomes that will be associated with each. For convenience, we will use the term “programs” to refer to all of these.
In some organizations, programs fall neatly into responsibility centers, such that each responsibility center manager prepares a budget for each of his or her programs. Alternatively, it also is possible that each program is a separate responsibility center, most likely a profit or investment center. When neither of these arrangements is possible, a more complex, matrix-like structure may be needed.
Regardless of the specifics, it is important for the budgeting phase to fit with both the organization’s strategy and the programming phase of its management control process. Additionally, by having line managers budget for non-financial as well as financial goals and objectives, senior management can relate each program to the organization’s overall strategic direction. This is not a new idea. Ford Motor Company included non-financial items in its budgets some 40 years ago. The approach was refined about 30 years ago by Texas Instruments. Today, it is used in many companies in many different forms.
Despite these changes, and the importance of budgeting to successful operations, the budgeting phase of the management control process remains anathema to many senior managers. They see it as causing a loss of valuable time and something to be finessed rather than to be taken seriously. As a result, many line managers devote considerable energy to game playing in the budgetary process rather than to using the budget as a tool to help them improve their performance. When this happens, budgeting plays a far less valuable role than it could.
When separated from programming, budgeting typically is concerned only with operating activities, which are assessed in two ways: (1) The operating budget, which focuses on revenues and expenses on an accrual basis; this budget is used as a basis for measuring the financial performance of operating managers. (2) The cash budget, which analyzes cash inflows and outflows associated with ongoing operations; this budget is used by the controller or treasurer to help manage the organization’s cash.
Understanding operating budgets requires knowledge of both the technical aspects of preparing a budget, and the fit of the budgetary process with a variety of other aspects of the organization. Understanding the cash budget requires knowledge of the difference between accrual accounting and cash flows. This note discusses operational budgeting only.