This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
A constantly recurring objection, not only to formal budgets, but to all attempts to make advance estimates, is that the volume of sales of most corporations is not under control, nor can it be foreseen. There is undoubtedly much truth in this assertion. Yet in the great majority of cases this difficulty is exaggerated. As a matter of fact, the manufacturer or trader should be able, within reasonable limits, to exercise a fairly close control over the volume of his sales; if not, his business is clearly on an extremely unsound basis. His past experience should give him a reasonably clear idea of the normal percentage of costs to volume of business in his line. And, while the mere process of increasing selling expenditures will not in itself increase the volume of business, the proprietor should be able, with reasonable regard to conditions, to estimate with fair certainty the selling expenditures that will increase his business to a predetermined volume.
It is also true that in many lines of business extreme fluctuations take place from time to time. Manufacturers of railway supplies, for. example, are able to sell more of their product when the railroads are prosperous, but no extra selling effort will maintain their sales when the railroads are not making money and cease to buy.
It is the business of the budget-maker to form a careful estimate of the probable results of increased selling- expenditures, giving due weight to all factors both favorable and unfavorable. His ability as a financial man will be tested by the degree of accuracy with which he can foretell the probable business conditions of the coming year.
In estimating the coming volume of business, three factors should be considered: (1) estimated expenditures during the coming year directed toward building up sales; (2) normal proportion of sales expense to volume of sales; and (3) probable effect of general business and financial conditions on the particular line of business.
The uncertainty as to the result of the selling effort is the crucial difficulty to be overcome. Once the anticipated volume of business is calculated, it is comparatively simple to determine the expenditures necessary for the proper handling of this estimated volume.
Another related objection to budget-making is to the effect that the business will fluctuate widely with business conditions and will not run in a uniform channel. This objection simply tends to show, first, that the budget should be made on a monthly rather than on a yearly basis with a view to increasing its accuracy and, in the second place, that a margin should be allowed for inaccuracies and fluctuations.
A third objection to all budgets is the alleged danger of introducing red tape and hampering the free judgment and action of operating officials, which is essential to an energetic and growing enterprise. The obvious answer to this objection is that the free and untrammelled action of sales managers, buyers, superintendents of factories, and other operating officials, has been probably the most prevalent cause of financial embarrassments.
As a matter of fact, a definite and binding budget, which can be debated and settled by all the responsible officials and the directors of a company at the beginning of a fiscal year, is a highly effective method of securing the unitedness of purpose which is an essential factor in every efficient organization.