Budgeting and Financial Management

A “budget” has been defined as a plan for the coordination of resources and expenditures covering a definite period of time.  While a budget can be created for the management of non-financial resources, such as manpower, the term is typically used in connection with the planned use of financial capital.  Companies and other organizations generally rely heavily on short-term budgets that cover one year.  However, common practice is to also prepare long-term budgets, particularly in those cases where large capital investments are required.  Long-term budgets often extend out five years or more, but they are generally broken down into annual periods.
This article is adapted from material in Finance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
The process of preparing a budget forces management to identify appropriate choices for the firm’s activities, determine the financial resources required to pursue each choice, and chooses those activities that promise the greatest reward (i.e., return on investment) in relation to the limited financial resources available to the firm.  While the process of preparing the budget is an essential management activity, it is just one part of the larger task of financial management for the firm.  Financial management involves identifying attractive investment opportunities, seeking and obtaining funds required to pursue the best of these opportunities, preparing the plans (i.e., budgets) for the utilization of these funds, and monitoring the progress of the projects in relation to the original budgets.
The budgeting process also has several other ancillary benefits.  For example, by tracking the firm’s performance against a plan or budget, management can quickly identify any variances that may require corrective actions or re-evaluation of the underlying premises for the original investment decision.  In addition, a budget or plan is a good method for evaluating the performance of managers or departments within the firm.  Finally, budget preparation provides a good opportunity for senior managers to review and integrate the plans and activities of different units within the firm.
In order for the budget preparation process to be effective, it should include answers to the following key questions:

• What are the overall business objectives for the firm? The budget is only useful in the context of specific performance goals for the firm, such as increasing sales or the firm’s market share or reducing costs.  By knowing the most important goals of the firm, the managers can set priorities among the various projects that could be implemented over the planning period.
• Who has the primary responsibility for seeing that the budget process is successfully completed?
• What parties must be involved in approving all or significant portions of the budget?
• Who has the primary responsibility for implementing and monitoring the budget once it has been approved?
• What review periods should be established within the budget?
• Does the budget process take into account the possibility of unforeseen events or problems that might alter original forecasts and projections? In developing countries, firms often run into unanticipated problems with sudden changes in foreign exchange rates or government regulations.

The budget process should produce a budget that is perceived as fair and acceptable throughout the organization.  Persons or units that may be disadvantaged by a proposed decision should be provided with an opportunity to explain their position and come up with alternatives.  Otherwise, morale will deteriorate along with commitment necessary to adhere to the performance requirements necessary to meet the budget.  Management must remain committed to the budget during the planning period, and the budget should not be changed absent clear and compelling reasons and full analysis and discussion.  If budgets are routinely abandoned or ignored, the entire process is trivialized.  However, this does not mean that the results of periodic reviews should be ignored if it appears that changes are dictated.
This article is adapted from material in Finance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedIn, Twitter and Facebook.