(b) The importance of budges as a means of planning and controlling the various business activities as well as the advantages and disadvantages of each source. In order to make effective decisions and coordinate the decisions and actions of the various departments, a business needs to have a plan for its operations. Planning the financial operations of a business is called budgeting. Although budgeting allows the organization to plan their work and work towards their plan, it also has both advantages as well shortcomings that can affect an organization’s progress.
The main advantage of a budget is it compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. By ensuring a budget is prepared, management is forced to look ahead. In addition, management, the strategic level as per say, is required to set out detailed plans for achieving the targets for each department, operation and as well as for each manager and this in return helps to shape the direction of the organization.
The second advantage of budgeting is it helps to facilitate coordination and communication in the company. By having a budget documented and cascaded all the way down to the organizational tier, Management can be assured that every stratum in the organization is aware of the company’s vision and mission. That said, having a plan to achieve the budget becomes easier. A budget also helps to clearly define areas of responsibility as it requires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control.
When each department derives the budget for their respective units, the accountability to achieve the said figures falls on the shoulders of the heads themselves. The heads, on the other hand, would have derived the figures based on the input from their department personnel. As such, if a certain aspect of the budget is not achieved, then the Senior Management is able to hold the person who came up with the figures responsible and an explanation can be sought. This helps to eliminate any blind finger pointing as each party is aware of what is required for them and the benchmark that they have to work to achieve.
The next benefit a budget offers is in the form of performance evaluation whereby a budget provides the basis for a performance appraisal. A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided in the form of variance analysis whereby comparisons of actual results against budget plan are made. Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and non-controllable factors.
Identifying this factors can help the business derive a strategy to rectify any problems faced and move towards achieving their desired budget, hence enabling remedial action to be taken as variances emerge. Last but not least, a budget helps to improve the allocation of scare resources for the company. It is a known fact that while there are a number of resources that help to make or break a company, some of them are scarce, for instance, large foreign direct investments. Sources like this, while it can be a significant catalyst, also do not come by on a daily basis.
As such, budgeting such resources can help management plan and fully utilize this scarce resources to the best of its availability. However, just like a coin that has two sides, while budgeting offers the management myriad advantages, it also has disadvantages that management should not overlook. Firstly, the budgeting process involves a lot of time and effort. This is owing to the fact that thorough research needs to be conducted before a management accountant can draw up the company budget.
It is also a known fact that this information comes from various strata in the organization. This becomes even more onerous when the environmental complexity increases. This is evident when situations such as the number of products, sales countries, customers and stages in the supply chain increase. When this scenario occurs, the budget preparation becomes more complex and time consuming that is to say it consumes longer hours to prepare a full budget. The second shortcoming of the budgeting process is that is places a huge emphasize on unduly short term financial control.
Budgets are usually prepared for a one-year period corresponding to the company’s fiscal year. Many companies even divide their budget year into four quarters followed by dividing the first quarter into months. These near term figures can often be established with considerable accuracy. The last three quarters may be carried in the budget at quarterly totals only. As the year progress, the figures of the second quarter is broken down into monthly amounts, then the third quarter figures are broken down, and so forth.
This approach has the advantage of requiring periodic review and reappraisal of budget data through out the year. However, the flaw in this approach is that it does not allow the management to forecast for a long run. This is owing to the fact that budgets do not take into account environmental factors such as recession and global issues. Thus, managers cannot prepare budget for a long run and this does not do much help to the organization especially when the budgeting process involves a lot of input. In short, this is a perfect scenario of cost overcoming the benefit.
Having a negative effect on the motivation of managers is the third downfall of the budgeting process. This is substantiated by applying the expectancy theory. Based on this theory, the budget, which also serves as a decision making tool, conveys information about the subordinates in the organizational as well as managerial level to those in the strategical level. Hence, a certain level of performance is expected from these subordinates and their effort is measured based on this said expected budget, using it as a bench mark.
When this situation occurs, managers, especially those who are in the technical line where the output of their effort cannot be clearly measured will feel severly demotivated. This is even more evident when these managers are not part of the budgeting process. Last but not least, the budgeting process gives emphasis on formal structure that leads to extensive and detailed planning at the departmental level. It is imperative so that budgeting process can be integrated into the forecasting and goal achievement activities.
Moreover it is easier to do evaluation whether they are performing in meeting targets that they have set previously. In a formal organization it is easier to analyze the inefficiencies and remedy the situation. However, having a formal structure in place is viewed as a burden by majority of the parties. This is simply because, budgets are only for internal use. Although having a formal structure would make analyzing the budgets easier, but the need for tedios details especially if it is non value adding only adds on to the workload of the respective employee and this does not lead to a positive result.
Thus, budgeting especially the guidelines and template of preparing it has a structure that is deemed to be excruciating by most parties . In a nutshell, the budgeting process plays a significant role in the organization despite its shortcomings. However, to obtain the greatest value from the budgeting process, companies need to adjust to the present realities. Only then will the business truly reap the fruits of a solid budgetary process.