Profit serves three purposes:

 

  • It is the ultimate test of business performance.
  • It is a reward for the risk and costs of staying in business, including obsolescence, replacement and entrepreneurial skill.
  • It ensures the supply of future capital for expansion, either directly by self-financing out of retained earnings or by attracting capital through dividends.

 

It is absolutely necessary, therefore, to plan for profits to meet these objectives, for at least a year ahead.

 

The profit for the ensuing year can be fixed. This in turn determines the required level of sales. The sales budget must be fixed for individual products or groups of products, taking into consideration an appraisal of market conditions. From the sales budget comes the expenditure budgets for material, labour and overheads. The cash budget demonstrates the level of financing needed month by month to achieve the sales and profit planned.

 

The planning process itself invariably leads to increased profits. It generates an attitude of mind which explores avenues for reducing costs, eliminating losses and increasing profits.

 

The Profit Plan with its supporting budgets should be divided and segregated according to the persons responsible: managers, executives and foremen. Each should have clearly defined objectives of the functions, results and expenditure for which he is accountable.

 

This stimulates initiative and enthusiasm within the general framework of control. By meeting regularly to review progress on the plan, persons become welded together into a dynamic and efficient team.

 

Source: Accounting for Control, W.B. Hales