When a company opens its doors to the public, the owner needs to consider what activities to focus on. These activities include servicing customers, evaluating new opportunities and financial planning. Financial planning involves anticipating future expenses and potential revenues through the budgeting process. Each company considers its own resources and planning needs as it approaches the budget process. For some companies, the preferred approach to the budgeting process uses functional cost centers.
Purpose of a Budget
Budgets serve several purposes for companies. The preparation of the budget forces managers and employees to consider the impact of different activities and the cost of those activities. This can provide an incentive for these managers and employees to reduce costs. Budgets communicate the expected financial performance of the company during the budget year. This allows the owner to determine whether he needs to obtain additional financing for that timeframe. Budgets also provide a benchmark of costs which senior management can use to evaluate manager performance throughout the year.
Cost Center Budget
A cost center budget separates the company into different cost centers. Each cost center represents a unit within the company, such as an individual department or a separate facility. The manager of that cost center maintains responsibility for developing the budget for her area. Companies can classify cost centers in several ways. These include geographic location, individual product line or function.
A functional budget considers the activities occurring throughout the company. The owner separates the budget into different segments based on the functions occurring in the organization. These functions include accounting, sales and production. The owner separates the company into functional areas and assigns responsibility for the budget to a manager in that area.
A functional cost center budget provides advantages to the company. The owner can review the expenses within each functional area. This allows him to compare employee wages or vendor charges for similar services or products. The owner can also determine his total cost for a particular function and determine whether or not to outsource this function.
Some disadvantages accompany functional cost center budgeting. These include not considering regional differences or permanent fixed costs. Regional differences refer to variations with wage rates or vendor charges in different locations. Also, some fixed costs within a function are permanent and would not disappear if the company chose to outsource that function, even though they are considered part of the functional cost center,