Profit Planning and Budgeting

Profit planning can be defined as the set of steps that are taken by firms to achieve the desired level of profit. Planning is accomplished through the preparation of a number of budgets, which, when brought through, from an integrated business plan known as master budget. The master budget is an essential management tool that communicates management's plan throughout the organization, allocates resources, and coordinates activities.

A budget is a detailed plan for acquiring and using financial and other resources over a specified period of time. It represents a plan for the future expressed in formal quantitative terms. The act of preparing a budget is called budgeting. The use of budgeting to control a firm's activities is called budgetary control.

Master budget is a summary of a company's plan that sets specific targets for sales, production, distribution, and financing activities. It generally culminates in cash budget, a budgeted income statement, and a budgeted balance sheet. In short, it represents a comprehensive expression of management's plans for the future and how these plans are to be accomplished.

Difference Between Planning and Control:

The term planning and control are often confused, and occasionally these terms are used in such a way as to suggest that they mean the same thing. Actually, planning and control are two quite different concepts. Planning involves developing objects and preparing various budgets to achieve those budgets. Control involves the steps taken by management to increase the likelihood that the objectives set down at the planning stage are attained and that all parts of the organization are working together toward that goal. To be completely effective, a good budgeting system must provide for both planning a control. Good planning without control is time wasting.

Advantages and Disadvantages of Budgeting:

Companies realize many advantages / Benefits from a budgeting program. Among these benefits are the following:

• Budgets provide a means of communicating management's plans through the organization.
• Budgets force managers to think about and plan for the future. In the absence of the necessity to prepare a budget, many mangers would spend all of their time dealing with daily emergencies.
• The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively
• The budgeting process can uncover many potential bottlenecks before they occur .
• Budgets coordinates the activities of the entire organization by integrating the plans of the various parts of the organization. Budgeting helps to ensure that everyone in the organization is pulling in the same direction.
• Budgets provide goals and objectives that can serve as benchmark for evaluating subsequent performance.

Disadvantages / Limitations of Budgeting:

While budgets may be an essential part of any marketing activity they do have a number of disadvantages, particularly in perception terms.

Budgets can be seen as pressure devices imposed by management, thus resulting in:

a) bad labor relations; and
b) inaccurate record-keeping.

Departmental conflict arises due to:

a)  disputes over resource allocation; and

b) departments blaming each other if targets are not attained.

It is difficult to reconcile personal/individual and corporate goals.

Waste may arise as managers adopt the view, "we had better spend it or we will lose it". This is often coupled with "empire building" in order to enhance the prestige of a department.

Responsibility versus controlling, i.e. some costs are under the influence of more than one person, e.g. power costs.

Managers may overestimate costs so that they will not be blamed in the future should they overspend.