Planning process of business operations ends with Budget as an output. Next step is implementation of budget. Budget statement includes financial and non – financial targets. Effective budgeting plays an important role in life of a business. Still it is just a piece of information which is useless without successful implementation. If activities are not carried out properly; all budgeting efforts go in vain. However, advantage of effective budgeting is that the organization works for the desirable targets.
Implementation means start of work for achieving the budgeted targets. Tactical managers (Department heads) will now assign targets to the relevant front-line (operational) managers. Front line manager then break down the one-year target in to small weekly plans e.g. production supervisor makes target for the weekly production and assign work to the workers. Tactical Managers also plan the methods to achieve the desired performance.
Sales managers search for different techniques to help their team e.g. offering commission for achieving sales targets, offering gifts, free samples, capturing more and more markets through advertisement. Production managers control the production process to achieve their targets. All other managers try and implement budget in their relevant departments.
Monitoring is essential to keep the things in line
Implemented performance is the actual performance and needs to be recorded and monitored. Recording is necessary to know what is being done. Monitoring is essential to keep the things in line. Control is the process of comparing the actual performance with planned and identifying the differences. These differences are called variances. Variances are calculated in every department and in as much detail as possible.
There are two purposes of a variance analysis. One is to monitor performance of departments and to identify if there is any difference that needs attention. Control action is then required to keep things in pace. Variance may be positive or negative in nature. Actual performance may be better than the planned since plans are cautious estimates. Even in that case we may need control action.
Suppose that a business plans to sell 12,000 units next year. Machines can produce 18,000 units in a year. But of course, the production plan is limited to the sales forecast. It is not wise to produce extra units; it will result in loss. Now the year starts and the sales are definitely divided in monthly targets. If you achieve 2,500 units sales in one month. Situation is highly positive but alarming and needs some action. First problem is that we have planned resources for the 10,000 units production. We have two alternatives; one is to arrange resources for the additional production required. We need more funds and more investments. We will need to buy more raw material and arrange more labor. Other overheads are also there. If we are unable to arrange funds and resources; we will need to slow down the pace of sales so that we would be able to be in market during the whole year.
Negative variances are also important to be calculated and controlled
Negative variances are also important to be calculated and controlled. This is important because negative variances will reduce the targeted profit. Reasons for the negative variances are to be identified and tackled. If these are uncontrollable; targets may need to be revised and for additional revenue we may need additional resources plans.
Second important reason of calculating variances is to appraise the performance of divisions or departments and the managers. Performance of managers is appraised to evaluate their performance for bonus and benefits and to control their contribution towards business profits. Performance of departments is evaluated to understand the factors that affect the profit contributed by the department and to eliminate any extra cost. When appraising the performance of managers, we should always focus on the “control of factors” by the managers.
Remember the basic theme is that actual things may differ from the planned ones but we always have to monitor those closely to take control action whenever necessary.