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Budgeting is indeed a key component in managing short and long term planning. To define a broad objective such as wealth maximization is clearly not sufficient to achieve the goal. It is very important for an entity to get into more details over how to work towards the objective. Businesses typically do this by crafting a long-term plan and short-term plan which I will be explaining in details.
Before I proceed, it is very important for us to understand what is budget and how it works.
A budget is a formal written summary (or statement of management’s plan for a specified future time period, expressed in financial terms. A budget becomes an important basis for controlling operations and evaluating performance. Thus, it promotes efficiency and serves as a deterrent to waste and inefficiency (Carlon, et al., 2009, p. 882)
There are several types of budget namely trade receivables budget, sales budget, finished inventories budget, trade payables budget, production budget, direct labour budget and many more.
The list continues and varies from industry to industry.
Budgets are generally regarded as having four area of usefulness. Budgeting promotes forward thinking and the possible identification of short-term problem. They can also be used to help co-ordinate various sections of the business. They play an integral role into motivating managers to perform better. Providing basis for a system control, and lastly
Budgets can provide a system of authorization for managers to spend within the limit. (Merchant, Hawkins, & Anthony, 2006, p.
560) The Planning process
Figure 1 the planning process
Source: (Banham, 2000, p. N.A)
The above shows the relationship between budgets, long-term planning and short-term planning. The budgeting process
The development of the budget for the coming year generally starts several months before the end of the current year. The budgeting process usually begins with the collection of data from each of the subunits of the entity. Past performance is often the starting point in budgeting, from which future budget goals are formulated. The budget is developed within a framework of a sales forecast that shows potential sales for the industry and the entities expected share of such sales. Sales forecasting involves a consideration of such factors as: I. General economic conditions.
Short-term planning or budgeting is a process that focuses on short term, commonly one year, and results in the production of budgets that set the financial framework for that period. It is likely to be expressed mainly in financial terms and is designed to convert the long-term plan into an actionable blueprint for the future. The short-term planning is mainly carried out by Tactical managers and Operational managers.
The budget will define precise targets for sales revenues and expenses, cash flows, short-term credit to be given or taken, inventory requirements, personnel requirements, increase profits, control costs, and invest for the future.
“Exercise aimed at formulating a long-term plan, to meet future needs estimated usually by extrapolation of present or known needs. It begins with the current status and charts out a path to the projected status, and generally includes short-term (operational or tactical plans) for achieving interim goals.” (Business Dictionary, n.d.)
The above is a definition of Long-term planning or Strategic planning is usually carried out by senior management. The long-term plan covers a period of at least three years (some go up to five years) on a quarterly basis, forcing the organization into that discipline of thinking further out than one year. These plans should be updated when the short-range plan is prepared.
Long-term strategies defines its overall effort in building market share, increasing revenues, decreasing costs, issues such as business take overs, expansion plans, deletion of business segments and radical product/service segment. (Budgeting, 2010)
The way in which planning process is conducted depends on the industry and culture of the entity. Nevertheless, the entity outlines its long-term goals and specifies its short-range plans in quantifiable terms which detail how it expects to accomplish its goals (Hillstrom, 2013, p. 4)
Now that I put the definition and the functions of long term and short term planning before you. We will now see the advantages of long term and short term planning. * The main difference is the time period involved. The maximum length of a budget (or short term) is usually one year, and these budgets are prepared often for shorter period of time. In contrast, long-range planning usually encompasses a period of 3-5 years. * A second significant difference is the emphasis. Budgeting is concerned with the achievement of specific short-term goals. Long-range planning, on the other hand, is a formalized process of selecting strategies to achieve long-term goals and developing policies and plan to implement the strategies. Management is also responsible to respond to opportunities and challenges with strategic response that arise from anticipated trends in the economic and political environment.
Thirdly, there is difference between the details in the planning. Short term planning can be very detailed, this is to provide a basis for control. While long-rang plans contain considerably less details, because the data are intended for a review of progress towards long-term goals rather than for an evaluation of specific results to be achieved. The main objective of long-range planning is to develop the best strategy to maximize the entity’s performance over an extended future period. Lastly, many entities today use a continuous 12-month budget by dropping the month just ended and adding a future month. One advantage of continuous short-term budgeting is that it keeps management planning a full year ahead, compared to just one-time planning for long term.
The preparation of budget is a valuable exercise as it forces management to look ahead and plan long term goal rather than to look back at the past. Once the long term goal has been set, a detailed short term planning can then be created. It is hence vital that budgeting is created as accurately as possible, as an error in data collection could affect the whole of the company’s operational and financial activities. The full benefits of budgeting can only be gained when the actual results are compared with the budgeted results then corrective actions are in place. Thus budgeting is a key component in managing short and long term planning.
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