BUDGETING

How does an operating budget work to discipline a firm's management?

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How does an operating budget work to discipline a firm's management?

Introduction

“It's not in the budget” is a familiar refrain. An unanticipated major repair, a long-standing grant that is not renewed these events can alter expense and revenue in ways that can compromise the ability of an organization to fulfill its purpose of profit maximization. A budget gives a projection of revenue and expense over the course of a year. It is a plan that communicates an organization's priorities and a tool that can be used to monitor revenue and expense. A budget is usually prepared by an executive director and approved by a board of directors. Operating budgets, program budgets, cash flow budgets, and capital budgets are frequently used by the business world.

Discussion

Budget Preparation

Operating budgets, often referred to as simply the budget, are prepared on a cash basis; expense is incurred, and revenue is received over the 12 consecutive months that make up the fiscal year. Usually, a budget is balanced; that is, revenue is equal to expense. The process of formulating expense and revenue projections often begins 6 months before the start of a new fiscal year. It involves the executive director, program director(s) or department heads, and the chief financial officer (if there is one). Typically, an executive director asks program directors to project expenses for their program. Revenue is usually estimated after expense. Revenue and expense planning may also involve the treasurer of the board of directors or a board finance committee. The board of directors formally approves the final budget.

The Budget and Managerial Control

As a plan, an operating budget communicates program priorities and sets fundraising goals. A balanced budget communicates a nonprofit's intention to preserve its resources. It projects neither a deficit (expense exceeds revenue) nor a surplus (revenue exceeds expense). Total revenue matches total expense. Program or program services along with administrative and fundraising or supporting services are matched with revenue sources. A balanced budget is a step toward preserving a nonprofit's resources for future generations. The current generation is generating sufficient revenue to cover current expense. This is the concept of intergenerational equity (Herzlinger & Nitterhouse, 1994). In addition to a planning document, a budget is part of a system of checks and balances designed to safeguard a nonprofit.

Internal Control

Internal control refers to procedures that protect the resources of an organization by documenting and then reporting on financial matters (e.g., financial statements, 990 income tax return, and audit). This approach reduces the probability of a recording error, fraud, or embezzlement. Internal control involves following generally accepted accounting principles (GAAP) promulgated by the Financial Accounting Standards Board (FASB) and American Institute of Certified Public Accountants (AICPA).

One dimension of internal control is documentation. Whenever a financial transaction occurs, it is documented; for example, a record of a check, payroll record, or receipt associated with a purchase. Financial transactions are recorded in a journal, which is simply a chronological list of ...