January 10th, 2018
How an Operating Budget Works to Discipline a Firm’s Management
One the importance of a budget to a firm is that it is a managerial tool for planning and controlling actions. When a company develops a strategy, the success of such a strategy is influenced by planning and budgeting for the actions that will be used to achieve such a strategy (Banham, 2000). Once actions are taken, the actual results and those that had been budgeted for are compared and the feedback is used to inform corrective action if any needs to be taken. Such a system, responsibility accounting, allows for evaluation of each unit’s performance and that of its manager (Bamber, Braun & Harrison, 2007). Through such responsibility center evaluation of actual and budgeted results, an operating budget provides a tool to assess a manager’s: use of planned resources in achieving the unit’s set goals and his/her ability to control the operations that have been placed under his/her responsibility (Bamber, Braun & Harrison, 2007). Examples of responsibility centers would be cost units where the responsibility is for expenses; revenue sectors where the primary duty relates to revenues; profit centers where both expenses and revenue responsibilities exist; and investments hub which is charged with ensuring prudent investments that comprises both revenue and cost aspects.
Elements of a Budget
A master budget often includes three types of budgets: an operating budget, a capital expenditures budget and a financial budget (Bamber, Braun & Harrison, 2007). For each of these, projections for respective elements are calculated so as to provide a basis against which actual results are compared. The operating budget, for instance, comprises the budgeted values for those items that are used in calculation of the operating income of a firm such as sales, inventory, purchases, and operating expenses which ultimately indicates the expected operating income for the financial period (Bamber, Braun & Harrison, 2007).
The capital expenditures budget, on the other hand, is the firm’s plan for procuring immovable property and other long term assets (Bamber, Braun & Harrison, 2007). The financial budget on the other hand comprises a cash budget, a balance sheet budget and a budget for cash flows statement (Bamber, Braun & Harrison, 2007). The cash budget presents the projections for the sources and uses of cash which then are reflected in the balance sheet at the end of the period and further in the cash flow statement (Bamber, Braun & Harrison, 2007). One category of sources and uses of cash are various elements found in operating in the operating budget whereas projected acquisitions of assets found in the capital investment budget provides another possible use of cash that is reflected in the cash budget.