Page 147 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Introduction

Budgets are an important tool for effective short-term planning and control in an organisation.
An operating budget usually covers one year and states the revenues and expenses planned for
that year. It has the following characteristics:
1. A budget estimates the profit potential of a business unit.
2. It is stated in monetary terms although the monetary amounts may be supported by non-
monetary amounts (e.g. units sold or produced).
3. It generally covers the period of one year but quarterly breakups, especially those that are
affected by seasonal factors.
4. It is a management commitment; managers agree to accept responsibility for attaining the
budgeted objectives.
5. The budget proposal is reviewed and approved by an authority higher than the budgetee
and ultimately, by the Chief Executive Officer (CEO).

6. Once approved, the budget can be changed under special conditions.
7. Periodically, actual financial performance is compared to budget and variances are analysed
and explained.

The process of preparing budget should be distinguished from (a) strategic planning and
(b) forecasting.

7.1 Relation to Strategic Planning

Strategic planning is the process of deciding on the nature and size of several programmes that
are to be undertaken in implementing an organisation’s strategies. The difference between
strategic planning and budgeting are as follows:
1. Both strategic planning and budgeting are planning activities in the two processes. The
budgeting process focuses on a single year, whereas, strategic planning focuses on the
activities that extend over a period of several years.
2. Strategic planning precedes budgeting and provides the framework within which the
annual budget is developed.

3. Strategic plans are structured by product lines or programmes while the budget is structured
by responsibility centers. This re-arrangement of programs - so it corresponds to the
responsibility centers charged with executing it - it is necessary because the budget will be
used to influence a manager’s performance before the fact and to appraise performance
after that.
7.1.1 Contrast with Forecasting

1. A budget is a management plan, with the implicit assumption that positive steps will be
taken by the budgetee – the manager who prepares the budget to make actual events
correspond to the plan. A forecast is a production of what will likely happen carrying no
implication that the forecasts will attempt to make actual, correspond to the forecast.
2. A budget is stated in monetary terms whereas a forecast may or may not be stated in
monetary terms.
3. A budget usually covers one year, whereas, forecast can be for any time period.

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