From the course: Accounting Foundations: Managerial Accounting

The purpose of budgeting

From the course: Accounting Foundations: Managerial Accounting

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The purpose of budgeting

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- A budget is a plan. Technically, it's quantitative expression of a plan of action that shows how someone or something will acquire and use resources over a specific period of time. The budget identifies and allocates resources necessary to effectively and efficiently carry out the mission of the organization. Although budgeting may sound to you like an unappealing activity, successful budgeting is absolutely critical to the success of a business. Whether we're talking about an individual, a family, or a large organization, the overall purpose of a budget is to clearly establish a plan so that performance in relation to a goal can be carefully monitored. Thus budgeting has a twofold purpose. The first purpose is to allow individuals or companies to develop a plan to meet a specified goal. The second purpose is to allow ongoing comparison between actual results and the plan in order to better control operations or activities. Budgeting is such an important activity that the top executives of most companies coordinate and participate in the process. Now, research and experience has shown that several behavioral factors determine how successful the budgeting process will be. First, the process must have the support of top management. Second, managers and other employees are more motivated to achieve budget goals that they understand and help design. And third, deviations or variances from the budget must be addressed by managers in a positive and constructive manner. A firm-wide operations budget could be prepared by top management, distributed to the major segments of the firm, and then further spread out to each lower level segment manager. This is the top-down approach, sometimes referred to as authoritative budgeting. The alternative is the bottom-up approach, also known as participative budgeting. Each division manager in a bottom-up approach prepares a budget request for his or her segment. These requests are combined and reviewed as they move their way up the organizational hierarchy, with adjustments being made to coordinate the needs and goals of individual units within the overall organization. Because both top-down and bottom-up approaches are legitimate, most organizations use some combination of the two. The blending of these two approaches will vary among organizations. A smaller organization with a few management levels will rely more on the top-down approach than will a larger organization. Top management in smaller organizations tends to be more knowledgeable about and more involved in the operating details.

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