Most companies prepare an annual budget, also commonly referred to as an annual plan. Top management, particularly the CEO, is responsible for approving the final budget, which then becomes the guidebook for operating the company. The approval process can sometimes take longer than the preparation of the budget itself, because difficult decisions have to be made about prioritizing expenditures. Making these decisions requires considerable back-and-forth discussion among the management team.
In corporations large enough to have departments or divisions, the managers of these functional units are responsible for preparing their own budgets, which they submit to the finance department. The departmental budgets are consolidated by the finance staff to create the budget for the company as a whole. The budgeting process often starts with top management providing guidelines for divisional managers to use, such as assumptions about what the economic environment will be in the upcoming year. Whether a manager’s budget gets approved or not is often a function of how closely he follows the given guidelines. If top management is trying to keep costs down, a manager who proposes a 20 percent expenditure increase for his department will most likely need to revise his budget.
The finance department conducts the initial reviews of the department budgets. They analyze the proposed expenditures, or in the case of revenue producing departments, the assumptions used to prepare the revenue forecast. They look for significant variances from last year’s budget. Their goal is to make sure each budget is reasonable and achievable. They also want to identify potential budget cuts in case top management decides the total proposed expenditures for the company are too high.
Top management looks at the consolidated budget and decides whether the revenue and profit forecasts are in line with the goals they set for the upcoming year. If projected profit is below what they expected, the company either needs to determine ways to generate additional revenues or make spending cuts to improve the bottom line profit. The analysis provided by the finance department is extremely useful in helping them identify the areas that need further explanation from the divisional managers -- or expenses that just seem too high and can be cut.
Senior management meets with each division manager, sometimes with a finance staff member in attendance, to get a better understanding of the budget requests the manager has submitted. The division manager must come prepared to defend his requests. Top management has to weigh the consequences of major budget cuts. Cutting marketing expenditures for example can have an adverse effect on future revenues. Top management has the difficult task of making sure each department has the resources it needs to function effectively while keeping total expenses low enough that the company can maintain profitability.
A department manager may not be happy with his final budget if he sees top management made significant cuts. But hopefully top management communicated the reasons for these tough decisions. When the budgetary approval process finalizes, each manager should feel fairly treated. Ideally, he feels he has ample resources to reach his departmental goals and as a result is ready to give a maximum effort in the upcoming year.