Budgeting

Budgeting is a process of coordinated planning and management of the enterprise activities with the help of indicators that permit to determine the contribution of each department and each manager in achieving of objectives.

Budget is a detailed plan of the enterprise activities, aimed at achieving of the corporate goals.

Budgeting is a process of construction and implementation of the corporate budget on the basis of the budgets of individual departments and divisions.

The most valuable thing that budgeting can give you is coordination of all aspects of the enterprise activities.

Availability of the budgeting procedure is a standard for any enterprise in the developed countries of the world, and in recent years it becomes a standard in Ukraine.

However, approximately half of the enterprises use budgeting system inefficiently. The short-term planning system is considered to be inefficient, when the deviation of actual results from the planned regularly exceeds 20-30%.

This situation is a serious problem, because the enterprise budget is the basis for adoption of prompt management decisions.

Non-performance of the budget could mean frustration of all plans of the enterprise for production, sales, payment of salaries, taxes, etc. This ultimately leads to frustration of the basic plan of any enterprise – development strategy.

At the same time there are typical reasons that lead to decrease in the efficiency of the budgeting business process.

Without providing of an exhaustive description, we will focus on those issues that are fundamental:

Process Organization

The basis of any business process is written regulations, which clearly set out rights and responsibilities of all units participating in it, forms and terms of the provided information, recipients of intermediate and target documents. If these regulations are absent, then the whole process can be held by one person, who determines both the effectiveness of budgeting and the fact of its existence as a business process. Besides that, in the situation, when it is not clearly prescribed who must do to whom what and when, so there is no one to put responsibility on for incorrect or delayed information. In this case, the budgeting system is not even something that is ineffective, but it becomes meaningless.

Let’s eventually emphasize the following requirements for the organization of budgeting business process:

  • availability at the enterprise of a single document regulating to the budget process;
  • organization of the budget committee;
  • establishment of strict financial discipline;
  • forming-up of priorities in finances;
  • distinct delineation of authorities and responsibilities of departments.

All this will be possible only under the condition that the company's management is aware of the importance and necessity of financial planning. Consequently, the most important thing in the process organization is involvement of the management team.

Methods of Budgeting

Common mistake is made by those people, who believe that the budget is a cash flow statement. The budget of the enterprise should include three forms: income statement, statement on flow of payment instruments and statement of balance.

Income statement is required to assess the profitability of the current enterprise activity. The essential in the income statement is division of costs into variable and fixed. It is necessary to understand how the enterprise activity results will change within variation of production volumes.

In the long-term horizon, the presence of profit, in particular, is the key to a positive balance of the statement of flow of payment instruments.

The main purpose of the cash flow statement is to ensure the solvency of the enterprise. Under the solvency we understand the ability of enterprise to perform in full and in due time payments required for normal (planned) operation.

Balance is the most important instrument in management of the assets and liabilities of the enterprise. The most relevant for enterprises in this context are problems of the current assets and liabilities turnover, as well as issues on optimization of the funding sources structure. The balance is methodologically calculated based on the income statement and statement of flow of payments instruments.

When the budgeting system is reduced to only one form of planning, cash flow statement, operational analysis loses fundamental concepts: marginal profit, profitability, turnover, etc. This narrows the problem field of the enterprise before resolution of the current problem of solvency and prevents from evaluation of the business efficiency as a whole.

Production planning

In the past decade, production activity of the most industrial enterprises has changed dramatically. Enterprises were forced to go from the mass production with small assortment to the short-scale, unique production. Assortment of output products at some enterprises has increased; life cycle of model range has reduced sharply.

Accordingly, the production organization is no longer relevant to current realities. Under current conditions, the production volumes have decreased, and at the same time the products assortment has expanded. Now enterprises need to produce a relatively small number of completely different products. Adequacy and efficiency of accounting often leave much to be desired. At many industrial enterprises residues on the shop floors and warehouses are removed once in a month, if not once in a quarter. The procedure for removing residues begins on the first day of each month and at the large enterprise with assortment of several thousand items, may take 3-4 days. Accordingly, the information on residues as of the first day of the month may be ready on the fifth day, when residues will be completely different.

Targets

Formation of the short-term plans (budgets) should be based on actual concluded contracts. Tasks for departments to achieve certain indicators should be set on the stage of medium-term planning (6-12 months). In this case, departments have time to develop appropriate programs and begin to fulfill them.

In the case of top-bottom establishment of parameters for short-term budget, the risk is high of its non-performance. However, quite often, in the short-term budget the revenue is planned for the next month, based on the annual business plan, or, for example, on the breakeven point, without taking into account the actual concluded contracts.

This is an example of incorrect display of the real condition of the enterprise, the profitability of which is 20% and the salary is not paid for three months. The value of profitability of 20% was determined by the Board of Directors. However, based on actual concluded contracts, the profitability would have been negative -15%. In order to achieve a “target figure” the plant produces uncertified products and even sells them with huge difficulties. Provided that 50% of products are sold on barter terms, other 50% is hopelessly stuck at dealers. Revenue and payments budget is performed only on 2/3. The reality of this situation is as follows: management leads business to bankruptcy with the profitability of +20%. From the objective point of view we have “bankruptcy”, and from the subjective point of view (falsely) – “profitability of +20%”.

Financial and economic system of the enterprise

Sometimes the financial and economic system itself of the enterprise reduces probability to achieve planned targets.

One can confirm that at the final result the budgeting process efficiency is determined by the efficiency of the enterprise’s work as a whole. In this case, implementation and use of the planning procedure help in a good way to identify and classify many problems of the company, which could have previously stayed in the background.

Therefore, companies with inefficient planning system are not the worst. They are still on the winning side with respect to those companies, where budgeting is absent. After all they have things to work on.

Budgeting system is a set of measures that are used to implement the budget process. It consists of the following elements:

  • responsibility centers;
  • financial structure of management;
  • methods of budgeting;
  • budget management;
  • fiscal consolidation.

Organization of budgeting at the enterprise is possible in the presence of:

  • system of responsibility and authority;
  • strict regulations of relations between employees;
  • qualified personnel;
  • adopted and prescribed functions of departments.

Financial structure of budget management involves:

  • distribution of primary and secondary functions in the executive office;
  • creation of suitable motivation system;
  • creation of high-quality information infrastructure;
  • definition of mandatory accounting centers;
  • definition of responsibility centers;
  • creation of internal rules and proper normative documents.