This chapter explains the budgeting process. It begins with an overview of what budgeting is and the budgeting process, and then uses four case studies to illustrate both profit budgets and cash forecasts for service, retail and manufacturing businesses. The case studies show how sales, cost of sales and expense predictions are converted using inventory requirements into purchase budgets, and how the cash flow forecast links back to the Statement of Cash Flows that was described in Chapter 6. The chapter concludes with a behavioural perspective on budgeting, and a critique of budgeting.
Anthony and Govindarajan (2000) described budgets as ‘an important tool for effective short-term planning and control’ (p. 360). They saw strategic planning (see Chapter 14) as being focused on several years, contrasted with budgeting that focuses on a single year. Strategic planning:
precedes budgeting and provides the framework within which the annual budget is developed. A budget is, in a sense, a one-year slice of the organization’s strategic plan (p. 361).
Anthony and Govindarajan also differentiated the strategic plan from the budget, on the basis that strategy is concerned with product lines while budgets are concerned with responsibility centres. This is an important distinction, as although there is no reason that budgets for products/services cannot be produced (they tend to stop at the contribution margin level, perhaps because of the overhead allocation ...