A budget according to Dry (2008) can be defined as a financial plan for implementing the various decisions that management has made or a quantitative expression of planned activities. In addition, a budget is an estimate of costs, revenues, and resources over a specified period, reflecting a reading of future financial conditions and goals. It an organization, it is one of the most important administrative tools, as it serves as a plan of action for achieving quantified objectives and is a device for coping with foreseeable adverse situations.
Budgeting is important in an organization because it helps in setting standards of performance, it plays a critical role in strategic planning and it provides a tool to measure organization results. Budgets usually represent a detailed analysis Of how a company expects to spend money in future time periods. Many companies create budgets on an annual basis so they can carefully outline the expected needs of each department in the business. Losing an annual budget process also limits the amount of time companies spend creating and managing capital resources.
On the other hand, there may be a general fear and countermanding about the purpose of the budgetary process and control, as it often regarded as time-consuming, unproductive, ineffective and meaningless rather than it being recognized as a tool for management, in all levels in an organization structure. Managers should be engaged in a detailed planned campaign on education and understanding the importance of budgeting as well as to encourage change from what has become an acceptable culture of imprudence towards budget preparation and suggest ways to make the budgetary process and the information become efficient, effective and meaningful.
Total involvement of all managerial levels in budgeting is very important. It is even more necessary to get the participation in budgeting especially at the lowest or supervisory level. Thus, budgeting is no longer seen as the sole responsibility of the chief executive officer, budget officer or as that of the top executive in the company. Rather, all levels of the company will participate in the budgeting process and make commitments to achieving the goals set by the budget. The principal advantage which may accrue from full participation arises mainly from a higher level of motivation.
Allowing a person to take an active part in planning and control should result in better co-operation. According to Horseman et al (1999), there are three major benefits of budgeting that states that budgeting compels managers to think ahead by formalizing their responsibilities for planning. It will also provides definite expectations that are the best framework for judging subsequent performance and budgeting aids managers in coordinating their efforts, so that the objectives if the organization as a whole match the objectives.
It will also clearly defines areas of responsibility which will require managers of edged centers to take responsibility to achieve the budget target for the operations under their personal control and it should provide a basis of performance appraisal. Budgeting has long been recognized as the accepted procedure for profit planning and many of the most successful companies have applied this procedure. However, the budget practice has been labeled fragmented, conservative, wasteful and ineffective by critics of the budgeting process.
Some view holds that budgets are primarily concerned with the allocation of cash to specific activities, and the expected outcome of business orientations and that they do not deal with more subjective issues, such as the quality of products or services provided to customers. These other issues can be stated as part of the budget, but this is not typically done. Also, when a company creates an annual budget, the senior management team may decide that the focus of the organization for the next year will be entirely on meeting the targets outlined in the budget.
This can be a problem if the market shifts in a different direction sometime during the budget year. In this case, the company should shift along with the market, rather than adhering to the budget. Furthermore, an experienced manager may attempt to introduce budgetary slack, which involves deliberately reducing revenue estimates and increasing expense estimates, so that he can easily achieve favorable variances against the budget. This can be a serious problem, and requires considerable oversight to spot and eliminate.
This concept and critic of budgeting has cast serious doubts on the need for a detailed and rigorously-enforced budgeting system, especially one that integrates the budget model with bonus plans. Nonetheless, the decision to install a budget is up to the management of the company. Management may opt to include a budget justification which is a narrative explanation Of each of the components of the budget, which ‘justifies’ the cost in terms of the Budgeting has long been recognized as the accepted procedure for profit planning and many of the most successful companies have applied this procedure.
However, the budget practice has been labeled fragmented, conservative, wasteful and ineffective by critics of the budgeting process. Some view holds that budgets are primarily concerned with the allocation of cash to specific activities, and the expected outcome of business transactions and that they o not deal with more subjective issues, such as the quality of products or services provided to customers. These other issues can be stated as part of the budget, but this is not typically done.
Also, when a company creates an annual budget, the senior management team may decide that the focus of the organization for the next year will be entirely on meeting the targets outlined in the budget. This can be a problem if the market shifts in a different direction sometime during the budget year. In this case, the company should shift along with the market, rather than adhering to the budget. Furthermore, an experienced manager may attempt to introduce budgetary slack, which involves deliberately reducing revenue estimates and increasing expense estimates, so that he can easily achieve favorable variances against the budget.
This can be a serious problem, and objectifications which is a narrative explanation of each of the components of the budget, which ‘justifies’ the cost in terms of the proposed work. The explanations should focus on how each budget item is required to achieve the aims of the project and how the estimated costs in the budget is submitted, all items in the budget should be justified. Reposed work. The explanations should focus on how each budget item is required to achieve the aims of the project and how the estimated costs in the budget is submitted, all items in the budget should be justified.
However, even though budgeting will be beneficial to the organization, it also has limitations in its preparation. The budget can be seen as pressure devices imposed by management resulting in bad labor relations and inaccurate accounting record keeping. There may be existence of departmental conflicts that may arise due to the allocation of resources and various department may be lamed when the target set have not be achieved.
The company will have difficult to reconcile against the company’s goals and individual goals and managers may overestimate costs so that they will not be blamed in the future should they overspend on the expenses and revenues. In most large organizations they will ensure that various type of budget are prepared to keep track of all expenses and incomes for the businesses. It will also help managers and account for a construct their annual report. The ability to budget effectively is an important element in order for an organization becoming successful.
There are several types of budgets used in the business may take any of these names; master budget, an operational budget , general cash flow budget, capital budget , and financial budget which will be defined below (Hormone et al 1999). Master Budget: This type of budget is comprehensive estimation on how management expects to conduct all aspects of business that will cover the budgetary period for a period of one year. It will summarize the estimated activity by cash budget, budgeted income statement and balance sheet.
It includes interrelated budgets from various departments which managers will use as a subset budget to plan and et performance objectives. This type of budget will used in large organization to ensure managers are kept on the same level. Operational Budget: An operational budget is the most common type of budget used. It forecasts and tries to closely predict yearly revenue and expense for the business. The budget can be updated with actual figures on a monthly basis and then you can revise your figures for the year, if needed.
Cash Plow Budget: A cash flow budget details the amount of cash that will be collect and pay out. This is generally tallied on a monthly basis, but some businesses tabulate this weekly. In this budget, you track your sales and other receivables from income sources and contrast those against how much you will pay to suppliers and expenses. When there is a positive cash flow, it indicates that the business is growing. Capital Budget: The capital budget helps you to figure out how much money you will need to put in place for new equipment or procedures to launch new products or increase production or services.
This budget estimates the value of capita purchases you need for your business to grow and increases revenues. Financial Budget: The financial budget will explain how the business will receives and spend the money achieved on a corporate scale from their capital expenditure. They will need to manage their assets which will have significant effect of the financial health on the company. However, managers will use this budget to help with leverage financing and value the company for mergers and public offering Of stocks.
Budgets serve a variety of functions which includes planning, evaluating performance, coordinating activities, communicating, motivating and authorizing actions. A properly used budget can provide a benchmark or comparison point that alerts management to the first indication that their financial goals are unattainable. Four elements must be present in order for a budget to provide this type of information and control. Firstly the budget must be well envisioned, and prepared or approved by management, whilst secondly the budget must be broken down into periods corresponding to that period’s financial statements.
Thirdly throughout the year the financial statements must be prepared on a timely basis and a comparison made to the budget and fourthly management must be prepared to take action where ever the comparison with the budget indicates a significant deviation. The budget process plays an important role in the planning, decision-making ND controls within the organization. Therefore, it is essential for the company to improve the budgeting process in order to have a better understanding of the strategic goals, garner more coordinated support for those goals, and to improve the ability of the company to respond quickly to competition.
There are several ways to improve the budget process. These are as follows: Link budget developments to corporate strategy Design procedures that allocate resources strategically. Tie incentives to performance measures other than meeting budget targets. Link cost management efforts to budgeting. Reduce budget complexity and cycle time Develop budgets that accommodate change The budget expresses how resources will be allocated and what measures will be used to evaluate progress, the budget development is more effective when linked to overall corporate strategy.
Linking the two gives all managers and employees a clearer understanding of strategic goals. This understanding in turn, leads to greater support for goals, better coordination of tactics, and, ultimately, to stronger accompanied performance. To create this link, companies must communication their strategies to employees. Top management must take the lead in developing and communicating strategic goals. However, to develop those goals, top management needs information about customers, competitors, economic and technological change information that must come from customer-contact and support units.
Companies that establish effective channels for communication find it easier to set challenging yet achievable strategic goals. Setting goals before budgeting begins makes it easier for budget developers at all levels. When this happens, budget developers create from the start budgets that support strategic goals and that, therefore, need fewer revisions. Budget development then becomes not only faster and less costly but also far less frustrating. Many companies still evaluate managers primarily on how closely they hit budget targets.
While this may seem logical, in reality this type of one- dimensional evaluation tempts managers to “win” by playing games with budget targets. Such game playing isn’t always in the company’s best interest. For many companies, meeting budget targets is secondary to other performance measures. Such companies use a balanced set of performance measures to chart progress toward strategic goals, and use the same assure in their incentive programs. This reinforces the importance of key strategies and communicates what results will be rewarded.
At many companies, business unit managers are involved in identifying the measures that are most relevant for their operations. Typically, some measures are financial, while others track progress in other efforts. For example, an appropriate nonofficial measure for one business unit may be product defect rate; for another, speed to market for new products. Once the measures are identified, higher-level management clarifies what targets each manager is expected to meet.
Managers and employees receive training on the company’s incentive program so that they understand the reason behind the rewards. By linking cost management efforts to budgeting, companies improve the quality of information available for managers to use in developing their budgets. Accurate cost information is fundamental to budgeting. Companies that use accurate cost management techniques and provide budget developers with ready access to cost information improve both the accuracy and the speed of their budget process.
Companies strive to reduce budget complexity and streamline budgeting procedures. Such streamlining allows management to collect budget information, make allocation decisions, and communicate final targets in less time, at lower cost, and with less disruption to the company’s core activities. By controlling the number of budgets that are needed and by standardizing budgeting methods, companies take important steps toward streamlining budgeting. Another key step is to minimize the amount of detail included in the reports used to develop budgets.
Also, in their effort to streamline budgeting, leading companies use information technology to automate budgeting and facilitate workflow. These companies make sure that budget developers are thoroughly trained in new technologies. This training, together with ongoing monitoring of information needs accompanied, helps best practice companies deliver the right information to managers, on time and at the right cost. By developing budgets that accommodate change, companies can respond to competitive threats or opportunities more quickly and with greater precision.
They can use resources efficiently to take advantage of the most promising opportunities. Furthermore, knowing that budgets have some flexibility frees budget developers from the need to “pad” budgets to over a wide variety of possible developments. This leads to leaner, more realistic budgets. Companies typically review budgets quarterly, monthly, or even weekly. By including in these reviews reports on changes in business conditions, companies alert managers that new tactics may be called for, if they are to meet their targets for the year.
While it is important that budgets not be revised to cover up for poor performance or poor planning, best practice companies choose to revise budgets rather than adhere to budgets that do not reflect current conditions. Some companies rely on “rolling” or continuous” forecasts rather than on traditional annual budgets. The chief difference between such forecasts and traditional budgets is that the forecast is updated with actual results as the company moves through the year. Figures for three or more subsequent quarters are projected in decreasing degree of detail.
One way in which companies build flexibility into budgets is to prioritize according to strategic importance action plans that were rejected due to resource limitations. By doing this, they can act swiftly and decisively if additional resources become available. Another way in which companies evolve budgets that accommodate change is to require managers to create scenarios based on a variety of assumptions about business conditions. The affordability of powerful information technology allows for the creation of many “what if’ scenarios.
This practice makes it possible for companies to respond more quickly and effectively if actual conditions follow the pattern of a particular scenario. Companies also build flexibility into budgets by setting aside funds at the business-unit level to take advantage of competitive opportunities. Some companies even establish separate subsidiaries to look onto promising products or technologies. It is imperative that the budget be viewed as an essential tool to help companies to formulate better strategies for achieving its goals and objectives.
The strategic planning is the long term plan of an organization and the budget is the short-term plan that contains more detail regarding the business operations. The budget is viewed as the blueprint or plan for the entire business which is prepared for the future period which it is designed by estimating and forecasting future trends in the market. The budget is used to evaluate the actual performance of a company r a section of the company with desirable performance which is based on a budget. It also provides information to the shareholders or investors so they may determine whether the business is a potential investment.
Therefore, an excellent budget process should have the ability to convert objectives and desirable goods or future estimated outcomes into data. The budget should also be viewed as one way of positively influencing the behavior of managers within the organization as there are very few, if any decision and actions that managers can take which do not have some financial effect and which will nor abstinently be reflected in a comparison between budgeted and actual result. The nature of budgets is probably the most important advantage that a budgeting process has over most other systems in a typical organization.
The ability to budget effectively is a very important part of being successful organization. This will been done through the exercise of preparing a budget which enables managers to promote planning, obtain directions, to make reasonable forecasts which will be serve as a monitoring tool which will predict financial support, promote communication and coordination, titivates and serves as a tool for evaluation and performance and ultimately determine how well the group’s mission statement will be accomplished.
In piloting the affairs of the organization a budget can be an extremely important and effective tool for management. However, to prepare a meaningful budget the organization must know where it is heading, its goals and objectives. As priorities change people should be involved in the budget preparation and approval process to ensure the resulting budget is fully supported as a budget is a tool of management, not a substitute for management.