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Next to double-entry bookkeeping and the copying machine, budgets are the most commonly used management tool. Practically every business, large or small, has a budget of some sort. And so has every hospital and every university. Above all, no government agency in the world operates without an annual budget. In fact, budgets are the only management tool that originated in governmental, rather than in business, practice. The original budget, as it was first developed in its modern form in England during the nineteenth century, listed revenues from taxes, custom duties, and so on one side, and expenses on the other. This showed whether the governments finances would be in surplus or in deficit and, thereby, whether to increase revenues, cut expenditures, or borrow money. It also provided the legal basis for a government department to spend money. Unless authorized in the budget, expenditure was illegal. It was thus the first effective check on the bureaucracy, the first systematic and orderly way of telling the governmental executive how much to spend and for what purpose. All budgets, no matter how constructed, still serve these original purposes. They enable managementwhether of a business, of a hospital, or of a government agencyto pull together its commitments, its plans and projects, and all its costs in one comprehensive document; the budget contrasts total expenditure with the total of expected revenues, thus arriving at a forecast of financial sources and financial requirements for the entire organization. Budgets still establish what planned and authorized expenditures are. And then budgets enable managers on every level to see whether events over the budget period actually follow the course predicted, or whether there is a shortfall of revenues, an excess of cost over the budget, or a significant change in economic performance of an enterprise, department, project, or product. Almost every business today uses the budget to forecast and to control its financial needs and financial position. In particular, a budget is needed to enable the financial manager to anticipate the cash requirements of the business and to The Manager and the Bud get 331 make sure that it obtains the necessary cash resources ahead of time. Every budget process, therefore, develops a cash flow budget. In most businesses there is also a capital budgetusually extending over more than one yearwhich sets expected needs for capital against the various sources of capital and thus provides the basis for allocation of capital resources among various capital expenditures (e.g., between proposals for expanding capacity and proposals for developing additional markets). At the same time, the capital budget enables management to see whether the plans for obtaining capital are adequate to the capital needs of the business and to take timely action to bring the two into balance.

THE BUDGET IS A MANAGERIAL TOOL But the budget has grown to be far more than a financial tool. It is, above all, a managerial tool. It is the tool around which an experienced manager organizes all planning. It is the best tool for making sure that key resources, and especially the resource of performing people, are assigned to priorities and to results. It is equally a tool of integration for the entire workforce, and especially a tool of integration for the managers in the organization. And it is a tool that enables the manager to know when to review and revise the plans, either because results are different from what was expectedwhether better or worseor because environment, economic conditions, market conditions, or technologies have changed and no longer correspond to the assumptions of the budget. The starting point for the budgeting process, especially in a business, should always be expected results. What results do we expect to obtain in this business over the course of the next twelve or twenty-four months? What results do we expect in this research department over the course of the next year or the next five years? Only when the expected results have been thought through carefully does one ask, And what efforts does this require? Budgets are expressed in monetary terms. But monetary terms should be seen as symbolic expressiona kind of shorthandfor the actual efforts needed, and should be based on real values, that is, on people and materials needed, on work needed, on capacity needed. Budgets, in other words, should always be used as a tool to think through the relationship between desired results and available means. If they are looked at simply as a statement of cost, they soon cease to be the managers tool for planning and control. Instead they may degenerate into a straitjacket that controls the manager and inhibits correct action. In particular, it is important to avoid the worst pitfall of budgeting, the pitfall into which government budgets tend to fall. This is the tendency to regard last years expenditures as being about right and to project them into the new budge Typically, in this kind of budgeting, the manager starts out with the budget for last year and then either adds 10 percent across the board or cuts 10 percent across the board. This may give her a symmetrical budget. But it also means that she has not used the budget as a planning tool and is unlikely to use resources where they are needed.

ZERO-BASED BUDGETING A remedy against this sort of projected budget is zero-based budgeting. Rather than starting with last years expenditures, the manager starts with the results he or she wants to achieve in a given area and asks, Is it the right area? Is it a priority area? And then, What is really needed to obtain these results? In a large and complex enterprise, it is difficult to subject all expenditure areas to these questions every year. Yet it should always be done for major expenditure areas. For less important areas, zero-based budgeting might be done every three years or so, rather than yearly. On such a rotating schedule, zero-based budgeting can, and should, be used in every organization as a tool for the periodic systematic review of all products, markets, and activities. Thus it serves as the tool of systematic abandonment of the obsolescent, the unproductive, the unnecessary. Just as important as zero-based budgeting is the realization that any time period for budgeting is an arbitrary one. A great many of the expenditures for which a manager budgets are, of necessity, geared to much longer periods than one year. This applies particularly to capital expenditures. In the first year of a project building a new plant, for instanceexpenditures might be very low and confined to what is needed to do preliminary engineering and architectural drawings. But this, in effect, commits the business to very large expenditures in subsequent years. And if those are not made because the money is not available, the sums spent the first year are wasted. The same applies to a great many other activities: research work; management and manager development; training, whether of workers in the plant or of salespeople; or sales promotion and advertising. All these activities require continuous efforts over long time periods to have any results. To budget for them on an annual basis is, therefore, self-delusion and likely to lead to waste in subsequent years when it is being discovered that the sums needed to make the activity produce the desired result are not available. These activities require life-cycle budgeting that shows the efforts needed over the life of the project or activity. TYPES OF COST Accountants have long distinguished three kinds of cost: One is variable cost, that is, cost that should fluctuate with the volume of operations, such as the cost of raw materials needed to produce a certain product, or the cost of direct labor The Manager and the Bud get 333 needed in its manufacture. Second is fixed cost, that is, cost to which the enterprise is committed by law or by past decisions, such as interest payments on money borrowed to create new capacity, the cost of maintaining capacity, real estate taxes, and insurance premiums. The cost of maintaining an employee pension plan is also a fixed cost. Finally, the accountant speaks of administered cost, that is, the cost of such activities as research, advertising and promotion, manager development, activities of the field sales force. These costs are determined neither by the level of operations nor by commitments made in the past, but represent managerial decisions.