A budget is not a budget until it has been carefully scrutinized by management. Even if the numbers add up correctly, they may not have been estimated properly. It’s middle-management’s job to assemble the budget, but it’s upper-management’s job to question the budget. They do this because the budget is the financial tool that will guide the organization in the coming year. Not only does it need to be accurate, it needs to be well-considered and realistic.
In our example, the company missed the mark rather dramatically, showing a profit margin 22 percent less than the one projected in the budget. What questions should management ask?
Why is the projected actual so far off from the budgeted amount? Perhaps it was the fault of the budgetingprocess being too optimistic or of a budget based on considerations unrealistic to the current situation. Perhaps there was a significant change in market conditions or materials costs. In any of these scenarios, management needs to understand why before it can accurately assess the new year’s budget.
Production costs for Units A, B, and C do not match their profit scenario. What gives? It may be that the unit production varies and standardization needs to be applied. If a more costly unit is not earning more exponentially, it may mean that (a) the unit is improperly priced, or (b) demand has slacked off and there’s too much inventory left in the warehouse. In either case, management must look at production standards and market demand before budgeting unit-production figures for the new year.