I completed my first set of US GAAP compliant Financial Statements in 2001, filing my first complete set of payroll, sales, and corporate income taxes that year for a client.  Over the years, I’ve worked for a variety of clients on a variety of accounting related projects, and I can tell you one thing I’ve learnt from my experience:  the goals of financial and management reporting are opposite, and they are in many ways victims of language and ‘political correctness.’

Say what you must, the truth is that the goal of businesses and management accounting or financial planning and analysis is to maximize profits.  For most businesses, most SMEs especially, the goal is to minimize profits.  If you’re taught at university, school or professional accounting training that the the ultimate goal is to maximize profits, well, then, you’re being taught wrong.  More likely, you’ve also the heard the statement about watching out for the stakeholder.  Well, sometimes it is in the stakeholder’s favour to not show a profit.  It’s all about perspective.  For many small businesses, a profit means a hefty tax.  A loss means money well spend t on your needs and not on paying money to the government.

The fact that financial and management reporting can actually point to opposite things as being beneficial for a business is representative of how misleading accounting and finance terminology and theory can be.  Just take management reporting, and you can read and write books on the difference between a budget and a forecast.  Some have decided, for better or for worse, which is which.  But for those of us who are more open minded, there are questions that lurk around this discussion that really don’t have an answer.

I once told a student that if after qualifying as a licensed accountant, if he could tell me whether a forecast drove a budget or a budget drives a forecast, he can consider is CIMA qualification to be a useful one.  But I can tell you, the chap has no chance of convincing me which should come first.  Some say that a forecast is simply an extension of past activity, while a budget is a defined plan of what the business plans to accomplish, spend, and do within a specified time.  But what really drives this budget?  Isn’t it supposed to be a sales forecast?  Or a forecast is based on the plan of what you can be expected to produce in a certain year.  Would you like to expect sales based on production capacity, or would you like to drive production based on expected sales?  No CIMA, ACCA, CPA, ACA, CMA, CFM or CFA qualification will discuss any of this, because the true, always right, never wrong answer to this question is “it depends.”

It depends on what?  Well, on whatever you want.  The preference, thought and management style of the management of a specific company drives the creation of budgets and forecasts, and there’s really no ‘right’ way to do this.  Yes, there are certain accepted formats to prepare a budget and a forecast, but let’s face it, the integrity of a document such as a forecast or a budget, which really has a subjective head or a subjective foot, is total speculation.  Think of it as a vicious circle.  Once you’ve decided which comes first, either the budget or the forecast, each item has to be revised based on actual performance compared to both budgets and forecasts, resulting in what is termed as a flexible budget.  So, not only can a budget drive a forecast, but a forecast drive a budget, and each figure can change, with the change be driven by actual activity.

Make sense?  Fear not.  The point of this article is not to explain budgeting or formatting.  Accounting, despite what many say, is an extremely inconsistent field, and no amount of experience can make just anything right.  There is no necessarily right process, especially not for all user groups or all audiences, hence the variations in the kinds of accounting you see today:  financial, management, environmental, forensic and systems to name a few.  The trick is to understand your business, and realize whether working on a budget driven from forecast model (a more of a just in time operations management approach) is better than the conventional “let’s churn out as much as we can” ideology, which can be very costly unless you have someone along the likes the Walmart or Carrefoure to forecast the unloading of  your budgeted production.

This entry was posted on Wednesday, November 12th, 2008 at 1:43 am and is filed under Accounting & Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.