A Note on Budgeting and Strategic Profitability Analysis

Abstract

A budget is a tool that allows an organization to put its strategy into financial terms. It can be described as the financial plan for the organization. The organization as a whole will prepare a profit plan, and it will also be concerned with investment in assets needed to achieve that plan and with cash flow being sufficient to support that plan. So it will typically have a profit plan, a capital budget, and a cash budget, which together will eventually result in a set of forecasted financial statements—an income statement, a balance sheet, and a statement of cash flow. This note focuses on the organization's profit plan. Excerpt UVA-C-2405 Rev. Nov. 5, 2018 A Note on Budgeting and Strategic Profitability Analysis The Budget A budget is a tool that allows an organization to put its strategy into financial terms. It can be described as the financial plan for the organization. A budget may be slightly different for different organizational units. Cost centers will typically forecast costs but may not forecast revenues or profit. Revenue centers will typically forecast revenues but may spend less time on an expense budget. Profit centers will typically forecast revenues, costs, and profits; accordingly, their budget is often referred to as a profit plan. The organization as a whole will prepare a profit plan, and it will also be concerned with investment in assets needed to achieve that plan and with cash flow being sufficient to support that plan. So it will typically have a profit plan, a capital budget, and a cash budget, which together will eventually result in a set of forecasted financial statements—an income statement, a balance sheet, and a statement of cash flow. This note focuses on the organization's profit plan. An organization's budgeting process is a process of resource allocation. Management inevitably has to make tradeoffs in a world with constrained resources. The budgeting process facilitates a formal look by management at the financial implications of different strategic priorities. It forces a discussion of tradeoffs and how resources will be allocated among those competing priorities. Ultimately, it results in setting performance targets and introducing accountability for meeting those targets. And it lays out a plan against which actual results can be monitored to make sure things are on track and going as expected. . . .