Question

Ethical Considerations. Budget projections always involve a degree of judgment because managers can never predict the future with total accuracy. For instance, one manager with an optimistic view and another with a pessimistic view could look at the same set of facts and arrive at distinctly different conclusions about the company’s financial prospects. When budgets will influence decisions made by investors or lenders, how should the people who prepare the budgets deal with the variance between optimistic and pessimistic viewpoints? On the one hand, being too pessimistic could result in lower levels of funding, which could be detrimental to employees, existing investors, existing creditors, and other financial stakeholders. On the other hand, being too optimistic could be detrimental to prospective investors or creditors. How do you find the right balance?

Answer 1

IA budget is the financial plan of the organization. It involves both revenues and costs. Since a fair amount of estimation is required in the preparation of the budget, it is subject to bias and error. There can be a substantial variance between the budgets if the viewpoint of the person preparing the budget is highly pressimistic or highly optimistic.

To reduce this variance to a minimum, an analysis of the past financial trends should be done. Revenue projections should be taken on the conservative side. However, they should not be much lower just to keep the variances favorable. An accretion of a certain percentage should be added to cost. To strike a balance between optimistic and pessimistic viewpoints, projections backed up by data should be considered and utmost accuracy should be maintained.