No one likes to run out of cash

To manage their spending, businesses, like individuals, need budgets. Budgets help managers and their employees know whether they’re on target for their growth and spending goals. Budgets are important for all types of companies: large financial institutions such as Citigroup, which suffered big financial losses after the housing bubble burst in the mid-2000s; large retailers such as Home Depot, whose profit margins are thin; profitable computer companies such as Apple, which sell high-dollar-value goods; and luxury hotels such as the Ritz-Carlton, which sell high-dollar-value services.

“Scrimping” at the Ritz: Master Budgets

“Ladies and gentlemen serving ladies and gentlemen.” That’s the motto of the Ritz-Carlton. However, the aura of the chain’s old-world elegance stands in contrast to its emphasis—behind the scenes, of course—on cost control and budgets. From Boston to Beijing, a Ritz hotel’s performance is the responsibility of its general manager and controller at each location. Local forecasts and budgets are prepared annually and are the basis of subsequent performance evaluations for the hotel and people who work there. The budget comprises revenue forecasts and standard costs for hotel rooms, conventions, weddings, meeting facilities, merchandise, and food and beverages. Managers monitor the revenue budget daily, review occupancy rates and adjust prices if necessary. Corporate headquarters monitors actual performance each month against the approved budget and other Ritz hotels. Any ideas for boosting revenues and reducing costs are regularly shared among hotels.

Suzanne Porter/Rough Guides/Dorling Kindersley, Ltd.

Why do successful companies budget? Because, as the Ritz-Carlton example illustrates, budgeting is a critical function in an organization’s decision-making process. Southwest Airlines, for example, uses budgets to monitor and manage fluctuating fuel costs. Walmart depends on its budget to maintain razor-thin margins as it competes with Target. Gillette uses budgets to plan marketing campaigns for its razors and blades.

Even though budgeting is essential for businesses, many managers are often frustrated by the budgeting process. They find it difficult to predict the future and dislike superiors challenging them to improve the performance of their departments. They also dislike being personally evaluated on targets that are challenging and prefer to develop budgets that they can beat. We discuss these issues and the ways thoughtful executives deal with them later in this chapter. For now, we highlight some of the benefits managers get from budgeting.

Budgets help managers accomplish the following:

Communicate directions and goals to different departments of a company to help them coordinate the actions they must pursue to satisfy customers and succeed in the marketplace.
Judge performance by measuring financial results against planned objectives, activities, and timelines and learn about potential problems.
Motivate employees to achieve their goals.

Interestingly, even when it comes to entrepreneurial activities, research shows that business planning increases a new venture’s probability of survival, as well as its product development and venture-organizing activities.^* As the old adage goes: “If you fail to plan, you plan to fail.”

In this chapter, you will see that a budget is based on an organization’s strategy and expresses its operating and financial plans. Most importantly, you will see that budgeting is a human activity that requires judgment and wise interpretation.