If you work in the business field, most likely you’re already familiar with creating budgets and planning for months or years. But have you ever asked yourself why are budgets useful in the planning process? Couldn’t we do just as good without them? Let’s have a look at the following things to consider when designing your budget.
Why Are Budgets Useful in the Planning Process? – Definitions
A budget refers to the quantitative expression of plans a management sets for a forthcoming period. They are prepared at different levels within an organization, depending on the needs of the company. For example, the master budget is the overall financial plan devised for the period, reflecting the goals and objectives set by the organization. It also includes the operating (planned sales and operating expenses) and financial (borrowing, cash management, leasing, etc.) budgets.
When it’s done properly, budgeting can be used as a planning and controlling system. Once the goals and performance objectives are written down in financial terms, the budget plans are used all throughout the year. There are also the monthly performance reports, which compare the budgeted results with the actual ones. Mainly, budgeting is concerned with planning and controlling every step, which is why it’s essential to know how to prepare the annual budget for a company, no matter how big or small.
The Planning Process
Planning is a process-oriented towards the future. And this is the first hint as to why are budgets useful in the planning process: they are both looking towards the future. Briefly, a plan specifies in one form or another what the management intends to do. In general, the management can control some of the variables, such as:
- plant and equipment;
- financial resources;
- production methods;
- human resources, etc.
As such, planning helps create forecasts and assumptions about the external environment of a company, which cannot be controlled. Some companies choose to have long-run, strategic plans that cover 5 years or more. Others prefer to stick to the classic one-year plan. Regardless of the duration, you can’t have a plan without including the budget.
There are various stages included in the planning process:
The first thing to do when devising the annual planning process is to establish the goals. You need to state them when it comes to return on investment, profit, market share, product leadership, product diversification or simply survival. Usually, a large organization sets a hierarchy of goals.
2. Performance Objectives
Also called targets, performance objectives are a way of implementing subgoals. They are specific and, more important, action-oriented, which means you can measure them in specific terms. For example, one performance objective might be to make $300,000 within the first quarter of the following year. The budget states formally the goals and performance objectives in financial terms for a certain period.
3. Integration and Coordination
Still wondering why are budgets useful in the planning process? Let’s go on with the explanations. To prepare the master budget, you need integration and coordination, which are part of the planning process. Coordinating all the organizational activities supposes integrating things like planned expenditures, revenue plans, financing needs, and asset requirements. At the same time, the coordination function is one of the most useful attributes of a budget. For example, the sales budget integrates with the marketing expense one, and this helps the company reach their goals.
Usually, the master budget is a pro forma financial statement which includes the budgeted amounts. As such, you can analyze the profit plan in the budgeted income statement. This is an operational budget that includes planned expenses and sales. Naturally, the budgeted sales and expenses are going to fluctuate, following various factors.
So Why Are Budgets Useful in the Planning Process? – Explanation
Now that we managed to define all the terms we need, it’s time to answer the main question: why are budgets useful in the planning process? If you have a look at the definitions above, you will see that the planning process relies greatly on different budgets. Whether we are talking about the master budget or other types, they are essential in creating the plans for the company’s evolution. Simply put, you can’t have a good plan without having a budget first. Besides this brief explanation, there are also other reasons you should consider:
1. It Helps You Stay Focused
A budget is useful because it helps you assess the long-term goals and work to achieve them. When you have a budget, it forces you to map your goals and save money. Otherwise, all the planning you made would go to dust. More importantly, you can keep track of the progress you make, and thus achieve the dreams you have.
2. It Stops Overspending
Without a plan and a budget set in place, many people tend to overspend. Whether we are talking about personal needs or professional priorities, having no budget at all makes it easier to overspend. What’s worse, you may even start borrowing money and getting credits for things that don’t represent a priority.
3. It Helps You Prepare
You never know when you’ll run into an unexpected situation or an emergency. Your equipment may get damaged, a natural phenomenon can affect your office or various employees may get sick. In such situations, the plan you have may be useless unless you rely on a budget as well. Including an emergency fund in your budget helps build a complete plan that makes you prepared for anything.
4. It Shows Your Bad Spending Habits
If you lay out all your expenses clearly in front of you, you can see if you have any bad spending habits. Maybe you are spending too much on some maintenance services, or maybe you are replacing the furniture when you don’t really need to. In any case, the budget helps make the planning process more efficient, both when it comes to cash and time.
Here you can watch a short clip on why you need to plan and budget.
To sum it up, if you got all the way here, then you don’t need to ask yourself why are budgets useful in the planning process anymore. You can’t start planning the activities in a company without talking about the financial aspect as well, which is why we can’t overlook the budget from the planning process.
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