However, with budgeting, management can easily see how much money is available for projects and what the most pressing issues of the company are. Without the budget, the company is doomed as it is unable to account for its cash flow and revenue streams (Sullivan, 2003).
Also, various financial models can be used to aid management. These tools can include sensitivity analysis and regression analysis. Sensitivity analysis in particular is a very crucial component within the overall business strategy of a firm. Sensitivity analysis helps properly forecast adverse scenarios under various market stressors. It also allows management to determine what variables have the greatest impact on the strategic outcome. Management must determine where capital should be deployed in the underlying business. Through budgeting management can determine to what extent capital should be deployed in a particular business. Budgeting is the foundation for proper financial planning. Through proper budgeting, financial planning can become more effective in the context of the overall business strategy. Budgeting overall should be a value added activity (Mittra, 2007). By linking budgeting to the overall strategic plan, management has a better grasp of the aspects of the business. This is particularly true is management extensively uses historical trends and competitive analysis of peer institutions. A budget is a plan that properly outlines income and expenditures and how these expenditures are provided. This is very common in business, particularly in our current economic environment.
A real world example of the concepts mentioned above comes from Bank of America. The company is currently engaging in a very dynamic budgeting and financial planning strategy termed "New BAC." In regards to the budgeting component, the bank intends to cut as many as 30,000 jobs, streamline operation, and invest in top management. This budgeting aspect provides addition capital in regards to the financial planning aspect. Here, Bank of America is exiting non-core businesses overseas and instead investing in its core franchise in an effort to bolster growth. Through budgeting and subsequent financial planning, Bank of America has a complete and comprehensive business strategy. What occurred with Bank of America is not new. In fact, it describes all the benefits that are incurred through proper budgeting. As the example above illustrates the company was better able to allocate resources to areas in which it had competitive strength. The company exited out of areas in which it did not have competitive strength which provided more cash for the company to allocate elsewhere. The company also shed jobs did primary to labor costs within the budget. All of these aspects have now allowed the company to regain its footing and compete on a global scale. How did this budgeting exercise help the company financially? Well the stock price has increased over 70% over the past 2 years, beating the market handedly. The company now has more cash than any other time in the last 10 years. It has better loan loss reserves in the event of another economic downturn, and it has some of the highest capital ratios in the industry. This would not have occurred without proper foresight and budgeting.
Many of the aforementioned concepts and principles would not occur without proper budgeting and planning. Concepts such as prioritization, prudent risk management, and high return on investment are aspects that are enhanced through proper budgeting. Budgeting aligns the overall company which helps allocate resources to areas that the most profitable for the business overall. Budgeting also provides a roadmap for management that allows them to only undertake projects in which the return on investment is high, and in areas where the company has competitive strengths relative to peers in the industry. It is for these reasons that I believe without budgeting management will be ineffective in delivering value and profitability.
1) Cliche, P. (2012). "Budget," in L. Cote and J.-F. Savard (eds.), Encyclopedic Dictionary of Public Administration, [online], http://www.dictionnaire.enap.ca/Dictionnaire/en/home.aspx
2) Sid Mittra, Anandi P. Sahu, Robert a Crane. "Practicing Financial Planning for Professionals" (Practitioners' Edition), 10th Edition. (Rochester Hills Publishing, Inc., 2007) sec. 1-3.
3) Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 312- 375. ISBN 0-13-063085-3.