“Budgets are often simultaneously used for the conflicting purposes of planning and performance evaluation.”
Introduction
A budget is a quantitative statement for a given period, including planned revenues, assets, cash flows, and liabilities (CIMA). Therefore, a budget acts as a projection for the company in that it helps in the coordination of activities. Hence, facilitating business control. Consequently, a budget is a tool that is part of the proper management of an organization, particularly in planning and control. Moreover, budgets help the management in planning and controlling the future operations of an organization budgets also serves as a device which coordinates complex activities of the business. Therefore, it provides a means of communicating financial reports of the company to stakeholders.
Budgeting is nothing but the means of identifying, collecting, summarizing, and communicating financial information of the organization. Thus, it involves the future planning of the organization. Budgetary control is the establishment of budgets that relates to the responsibilities of business executives to the required policy and comparison of real budget results in order to secure actions of individuals, as well as to provide the basis for revising the budget. From this point of view, budgetary control is a performance evaluation at the time of budget making.
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There are different functions of budgets in a company. However, they are not necessarily congruent with one another, but conflicts (). Budgets are concurrently used in many organizations for both effective planning and performance evaluation. Past studies have recommended the use of different budget levels for direct functions to solve any conflicts that may arise between budget functions (). To examine the statement of whether and why companies do so, it is important to discuss the potential costs that emerge for budgeting conflicts. Don't use plagiarised sources.Get your custom essay just from $11/page
The purpose of making budgets in an organization based on the perspective of management accounting
The budgeting process is used in management accounting for planning and performance evaluation. Therefore, it works a critical planning an evaluation tool on responsible individuals that are involved in such activities. Thus, the following are the purpose of making a budget in management accounting:
Planning
This a budgeting process that begins with the establishment of specific performance targets, which is then compared with the actual results, and this is performance evaluation. Budget plans are made after considering the objectives of the company at different levels. Budgets are the reflection of the future course of action within the organization. As a result, budgeting helps management accountant to fix flexibility and accountability issues for each activity undertaken in the company. Therefore, the management team uses budgets to communicate the whole expectation of the organization, and this helps in reducing business costs. Also, management use budgets as a planning tool, and this, in turn, motivate workers to achieve their organizational goals.
Performance evaluation
Budgetary control involves the establishment of budgets and continuous comparison of real results with the cost plan. The management uses budgets in performance evaluation in order to compare the actual results against the forecasted or budgeted plan to obtain the differences then, identify the leading cause of such variances. So, management accountants work to fix such issues in the future to make constant improvements in performance. Furthermore, management use budgets to evaluate the performance of every employee, particularly managers that are responsible for specific activities so that their performance and decisions are evaluated accordingly.
Budget development and application in an organization
The implementation of budgets depend on the organizational objective, and therefore, a company should follow the following procedures while developing and implementing their budgets:
Strategic plan. Every company should define the reason for its existence, including objectives it hopes to achieve not only in the near future but also in the long run. Hence, this is all about the mission and vision statement of the company.
On the other hand, a strategic plan is how an organization is planning to achieve its business mission. Firstly, the budgeting process should contain a documented plan to attain the organizational mission. This ensures that the resources of the company are utilized in supporting the policy of the company and developing the same, and this means budgeting towards achieving the vision of the organization.
Business objectives. These are nothing but organizational goals based on business activities. Yearly business objectives involve the steps a company takes to implement its strategic plans. Therefore, these objectives that the budget should finance. Business goals need a clear responsibility of the management team, its Board of Directors, and shareholders since they are solely responsible for attaining organizational goals. For instance, if a company has increased its facilities, and it also has the objective of increasing space, there is the need for fund budgets for the same in order the expand business operations to anew and spacious location.
Projection of revenues. This should be based on the past performance of the company as well as the basis of future forecasted growth in earnings. The projected growth in earnings can be obtained from the objectives of the organization. That is the mission of the company and strategic initiatives that are likely to lead to business growth. For instance, if the organization plans to increase its sales revenues by 15 percent, a budget should be created with the consideration of the projected growth for the financial year.
Projection on fixed costs. This involves looking at periodical predicted costs that either fail to change or remains constant over a given time. For instance, employee compensation costs, utility costs, mortgage payments, and insurance costs are some of the fixed costs. Furthermore, if the projected fixed costs are likely to rise or fall, then similar needs are necessary for fir budget development.
Projections on variable costs. These are costs that fluctuate or change from time t time, and they include supply and overtime costs. Therefore, they are expenses that can be budgeted, and they should be controlled. For example, if a company records higher sales during festive seasons, there will be high overtime costs but temporarily. Thus, such costs should be budgeted accordingly to meet extra overtime expenses in the company.
Yearly expenses. Goal-related costs should be included in the budgets. The initiative of every company is to have projected expenses associated with the business objectives, and these should be budgeted. Therefore, the cost of implementing goals are either considered or added to the departmental budget because it is responsible for completing the goal. This is essential since it fixes the responsibility and accountability of business objectives. For instance, when the sales department has forecasted to increase sales by 20 percent, the related costs with such increases as additional marketing and transport costs should be included in the budget.
The target profit margin. Every company where it is non-profit making or profit-oriented must have a profit margin target. This enables organizations to receive a return on investments. However, non-profit making organizations can use their proceeds in reinvestments on additional facilities and development of the firm. Therefore, the profit margin of the company can be obtained from the mission statement. Profit margins form an essential component of each company. Hence, healthy profit margins indicate the financial strength of the company. So, every budget that is developed in the organization must consider the profit margin to make a realistic budget.
Each budget that is developed in a company needs approval from the relevant authorities such as the Chief Executive Officer, Board of the company, and departmental heads. Additionally, the approving authority should review the budget regularly to keep track of the actual performance against budgeted performance. Evaluating the actual performance is as important as the definition of budgeted performance. This provides the measure of the budgeted objectives so that they are on track. Any slippage will be handled on time. It is necessary to perform this procedure monthly to make corrections to overspending and other modifications to the required budget. Therefore, waiting until the end of the financial year to make such adjustments may negatively affect the outcome of the final budget.
Budget variances. Dealing with budget differences is the last step that management accountants perform in developing and implementing the budget of a company. The entire budget variances must be reviewed in time by responsible persons and department managers. However, questions should be asked as to why such variances exist and why they are either positive or negative. Since reasons are significant, and if they can be controlled, then it is essential to have an emergency fund to help to solve such differences in the budget. For instance, if the historical system goes down suddenly and needs replacement, this represents a budget variance that requires funding. An appropriate budgeting process helps in developing, improving, and advancing the company. On the other hand, poor budgeting can affect the organization in negative ways. Thereby, affect the financial condition and viability of the organization in the long run.
Roles of the budget in an organization
A budget is created and properly used; it can provide a useful as well as valuable information to the company regarding direction, capital, and expectations. Furthermore, it helps in planning, projection, communication, coordinating, motivating, delegating, evaluating performances of the company, and facilitating decision-making processes. The following are some of the roles that budget plays in an organization based on management accounting perspective:
Budgets provide a means of financial forecasting and planning. That helps in projecting different activities and events within an organization. Because planning is key in the budgeting process, the implementation of a budget process can enable an organization to make the best possible plans with the best resource actions in the company. As a result, budgeting enables managers to anticipate business problems before they arise. Therefore, budgeting allows managers to foresee risks prior to their occurrence. Based on this, preventive measures are taken to avoid such scenarios.
Budgets provide a system for authorization. The process of budgeting offers a clear definition of responsibility and accountability of each activity in an organization. This helps in identifying the right individual that is responsible for any adverse results. This makes every department and its managers more responsible and accountable. Regarding this, budgeting ensures that organizational resources are appropriately utilized in the best possible way to provide maximum production, which in turn aid in profit maximization of the company.
Budgets are the channel for communication and coordination. That is, budgets provide an important means of communication, and this enables managers in different departments of the company to be informed about the business strategies and policies. Through budgets, the top management team can communicate with lower-level managers by informing them about the future expectation of the company. Besides, the budgeting process compels managers to examine the interrelationship and dependency among organizational departments. During this process, any arising management conflict is identified and resolved.
The budgeting process acts as a motivational device. Therefore, but plays an important role in influencing the behavior of managers. At the same time, it motivates managers to perform under the objectives of the company. For example, when employees actively participate in the budget-making process, it is used as a tool that helps managers in better unit management. Therefore, budgets act as a motivational means for solving organizational challenges.
Budgets are used as a means of performance evaluation and control. It implies that budgeting helps managers to control various business operations for which they are responsible. The actual figures can be compared with the budgeted results, and corrective measures take accordingly. By undertaking this process, managers can determine activities that are not conforming to the actual plan and need management attention since a budget is nothing but a performance measurement tool where a comparison of actual performance is made. Various management decisions are taken based on either the negative of positive variance.
Findings
https://hbr.org/1977/07/conflicting-roles-in-budgeting-for-operations
The budgeting process often highlights conflicts among top managers, objectives, and the reality of the company’s capabilities (). The management can both identify resources through budgeting to achieve organizational goals and learn the application of such resources. If the actual resources cannot meet the planned goals, operational budgeting can bring about examinations of financial implications of allocating additional funds.
There are three primary roles of any budgeting system, and all of them conflict in terms of planning versus motivation, evaluation versus motivation, and planning versus evaluation (). By examining the differences between the requirements of each role leads to significant conflicts.
The conflict between planning and motivation arises from the perspective of managers who prepare the budget. Therefore, they may know that for planning purposes, a company needs the best projections of the probable level of activity for the next year. Additionally, managers may know that their superiors are likely to increase the probable levels of operations required for planning purposes to reflect the objectives that are considered difficult to attain.
Conclusion
Firms trade-off costs against behavioral expenses of reduced credibility, when there is a deviation of performance evaluation from the planning budget. Based on the above discussion, budgets are important organizational aspects, and if the process of their preparations is followed diligently, it enables an organization to improve its financial results. This, in turn, adds value to the investment of shareholders. A reasonable budget helps in the identification of weak areas within the organization towards which managers can work to fix them. Additionally, budgets are important to the organization in the sense that it helps in improving workers’ efficiencies, controls expenditure, helps in correcting financial deviations, utilize the resources of the company in a useful manner. However, budgets have potential limitations because their estimates are based on different assumptions, and this may prove to be inaccurate over a given period; thereby, organizational departments can be rigid to change. Nevertheless, it is worth to conclude that a sound budgetary system is the most crucial part of the company, particularly those that work towards improving better financial results.