Budgeting as an instrument of profit management at the company

E. A. Baklanova,
L.N. Ustinova

Profit is the simplest and at the same time most complex category of market economy. Its simplicity is determined by its being the core and the main driving force of economy of market type, the basic stimulus of business activity in modern economy. At the same time, its complexity is determined by variety of intrinsic properties as well as variety of constituents and the role it plays in the market economy development.

The famous Ukrainian economist I. Blank offered the following definition of profit: "Profit represents the net return on investment (ROI) of the enterprise expressed in the monetary form and describing its compensation for risk of the enterprise functioning; it is the difference between the gross revenue and total expenses of the economic activity".

Profit plays a many-sided role in the development of market economy.

Profit guarantees to businessmen the return on investment, and at the same time it is a source of expenses related to the development of production and social sphere. The government has an interest in profit too, because a large part of it is transferred to the budget to back up state expenses. Commercial banks, various financial institutions, shareholders etc. are also interested in profits of enterprises. A growing profit makes financial market move faster, and its role in the redistribution of capitals and their more efficient use increases.

Now Ukrainian top managers make most use of the approach which presupposes breaking the profit management process into two parts:

• profit formation management;
• profit distribution management.

The profit formation management includes the development of policy for managing profits of operational, investment and financial activities. The basic constituents of these activities are income, expenses, tax payment, risk management.

The profit distribution management includes management of duly payment of taxes and collection of other compulsory payments related to profit as well as optimization of the proportion between the capitalizing and usable profits.

Thus, the profit management process requires a scrupulous approach to planning, implementation and control of each component of profit.

In our view, such approach is budgeting.

Budgeting is a technology of drawing up, updating, controlling and assessing of budget execution; it is one of corporate management technologies.

The budget is a financial plan covering all sides of enterprise's operation, which makes it possible to compare all expenses and gains in financial terms both for whole forthcoming period and for separate time spans.

Budgeting is implemented in two directions:

1. Preparation of functional budgets, that is departmental budgets. There should be determined income generation and expense centers ("the budget centers") as well as clear economic parameters (including specific expense items) that should be supervised by each structural unit and should be the responsibility of department heads having appropriate ranks.

2. Development, formalization of calculations, updating the specifications of raw and other material expenses as well as other production spending (heat and energy, repair and preventive maintenance of the process equipment etc.).

Drawing up the budgets of separate departments forms the basis for determining the overhead expense rate between individual kinds of production. It allows calculating the total prime cost of industrial production.

On the basis of budgets of all departments the consolidated budget of the enterprise which includes operating and financial budgets is made.

The operating budget is comprised of combined expense and income budgets which provide for drawing up a profit and loss statement. The operating budget includes budgets of sales, stocks, direct material inputs, direct payroll expenses, production and overhead costs, the cost price of final production, cost of sales, sales expenses, management expenses, a profit and loss statement.

The financial budget is a total combination of budgets which reflect the planned money resources and financial state of the enterprise. The financial budget includes the capital investment budget, the money budget, and the budgetary balance.

The advantages of budgeting are as follows:

• The top management of the company receives overall information to be used in order to obtain a full-scale picture of the enterprise development and to control its operation.
• The key information is provided as regular reports including analysis of plan/fact indices deviations as well as comparison of financial parameters.

Provisions are also made for

• Periodic planning;
• Cost-norm of industrial expenses;
• Coordination and cooperation.

The difficulties of implementing budgeting are as follows:

• Absence of separate information on production expenses;
• Accounting, tax-oriented approach to expenses, their analysis, per item distribution, grouping, and planning;
• Absence of expense account and control system in places of origination;
• Tie-in of planning and internal administrative reporting periods with tax reporting periods;
• Overestimation of the expected effect from the introduction of information technologies;
• Absence of real interest on part of top management;
• Absence of systems approach to the administrative accounting;
• Fear of social conflicts, inertia of top management and owners of the enterprises, unwillingness to get involved in long and complex processes of organizational and administrative changes.

However comparison of all pro et contra shows that the budget system implementation allows to balance income and expenses, to be flexible in the world of business, and consequently to receive profit.

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