Essay: The use of budgets in companies

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  • The use of budgets in companies
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Budget is intended to control the general finance of companies in regard to the fiscal year, but can be arranged into quarterly, monthly etc., which is intended to coincide with company’s annual report, but it can also be extended to a shorter or longer period depending on company’s need or requirement. Budgeting is not as easy as one would expect but rather a strategic plan which if well implemented puts an organisation in good future financial sounding. Budget has to emerge naturally if well implemented. Companies use budgeting system to facilitate and control its financial spending within a fiscal year. Budget tend to identify areas where the need to spend more or less are.

Reasons for budgeting can be five-fold: ORGANISATION, CONTROL, HABIT, EMERGENCY FUND and to ACHIEVE GOAL. (Jennifer VanBaren. 2014)

• Organisation: companies use budget to arrange their financial position as regard to taxation and what amount to put aside for future spending.

• Control: gives companies control on how its finance are used and for what it can be used on, it also helps to reduces unnecessary spending.

• Habits: this reflects on the spending habit of companies by making them understand what expenses it spends its money on, thus giving information on what it spends previous year against what it tends to spend in the next fiscal year.

• Funds: with proper budget planning, companies are able to save and put money aside in case of an unforeseen situations (emergencies).

• Achieve a set goal: when budget is put in place, financial goal is reached and companies are able to plan for new investment or acquisition; or make some adjustments that will not put the company in a bad financial position.

Typically, the above points can be broken down into three major uses of coordinating, planning and controlling, which in turn makes sure there are no unnecessary wastage and everything is accounted for.

There are different types of budgets; but for I will be focusing on INCREMENTAL BUDGET. On the other hand, incremental budgeting is based on the performance of previous budget, it acts as a basis on which any amount of money is added to the budget current. It is a simple approach that cuts down on the amount and time that will be spend in making the budget. Though it has its advantages and disadvantages. (Tutor2u. 2015).

As stated earlier, budgets help companies to plan and arrange its finances against changing markets. In such situations each system is used differently as it suits each company needs.

Incremental budget is a budgeting system that involves the use of current budget as a back drop for next budget. Incremental budget is quite easy to implement due to its simplicity as it is based on recent financial statement or results with real verification thus it helps in making funding stability as it is structured in a way to fund what is coming into what has been planned by the company. This approach makes it possible for each business department to have control and operational stability in its implementation. (Accounting Tools. 2013)

Incremental budgeting always begins with the budget from the last period. Once there is an established starting point, if a department needs more money than the previous budget, they have to be able to justify the extra expenses, and also, if you do not use your budget, then the next period’s budget will be reduced. This type of budgeting often leads to wasteful spending by employees because they do not want to lose their budget, and as such would not want to be questioned by the management on reasons for either over or under spending.

Incremental budgeting always begins with the budget from the last period. Once there is an established starting point, if a department needs more money than the previous budget, they have to be able to justify the extra expenses, and also, if you do not use your budget, then the next period’s budget will be reduced. This type of budgeting often leads to wasteful spending by employees because they do not want to lose their budget, and as such would not want to be questioned by the management on reasons for either over or under spending.

The advantages of incremental budget…….

Incremental budgeting is the easy to implement as long as it is believed that the future flow of cash into the system will not be interrupted. This is best for businesses with continuous income generation and the management can easily make adjustments toward the current fiscal expenditures. It gives the planners foresight into what is needed for the coming year. Thus incremental budgeting calls for partial variations in the sharing out of the capitals.

It lets businesses to better comprehend the size of their budget and focus on the reduction of interdepartmental conflicts regarding fund allocations. Incremental budgeting is easy to appreciate and the shrewdness required are relatively simple and straightforward. This method has the benefit of generating budgets that are comparatively stable, with gradual changes from year to year.

One of the disadvantage of incremental budgeting is that in most cases it does not facilitate improvement as managers, in order to justify funding, have to get used to having and spending same amount year in year out. It has to be noted that when a department has underutilised its fiscal allocation managers tend to use up the remaining amount on things, so as not to put next year budget at risk of being reduced from what it’s currently allocated. Incremental budgeting always assumes the appropriate funding levels, even in cases where the funding is too high for the intended purpose or too low to maintain the long-term operation of a program. (Brian Bass. 2015)

Incremental budgeting does not actually give enticement for development of new ideas because it lacks the capacity to new novelty ideas. When there is reduction in expenditure there are the likelihood of reward since there in room for such in the budget.

To some extent this system of budgeting may end up be redundant and of little importance in what it was intended for. This could be as a result of change in resource priority may have changed since the budgets were set originally. There may be budgetary slack built into the budget, which is never reviewed as most managers ted to overestimated their budgetary requirements, previously, in order to acquire a big budget which is lot easier to work to with, and which could give them room to achieve more favourable outcomes.

Conclusion:

Budgeting plays an important role in the economic life of companies through the revenue and expenditure measures of its fiscal budget. The economy and the budget are interrelated. In addition, the economic consideration indicates that the budget has some functions such as in allocation, distribution and stabilization. Besides that, budget provides assessment of the economic conditions of the company. If the productions of the company are increased, the income it generates will also increase. As a concluding remark, it is not wrong to say that budget is the backbone of every business organization, without which the smooth operation of an organization can be totally be disrupted. Thus, proper and prudential budget planning and implementation are needed from all department with regard to achieving its fiscal goals.

Like most topics of market economy, budget is highly very technical and as well a painstaking process to implement. It strides across most political, social and economic issues that bestrides any market.  and it lies at the root of many contemporary political and social problems. Some economists do see budget as a representation of “life and death” of company or government existence, because it’s through it that what need to be done is planned and funded and anything that is not of any importance is discarded. A budget, in other words, is the final analysis of company policy: who gets what, when, where and how. Ultimately, the process of administration, management manpower and any other business process of any company all come down to budget numbers.

PART TWO:

In recent years some business has formulated alternative budgeting system to Incremental Budget, this are Rolling Budget, Zero Base Budget (ZBB) and Activity Based Budgets (ABB).

The Rolling budget, also known as continuous budget, is continually amended as a result of variants that has risen during the fiscal periods due to changes in company’s circumstances. For example, at the end of a month, another month is added to the end of the budget, which makes it look like ongoing and never-ending budget, thus the alternative name of Continuous Budget.

Rolling budgets thus tend to be used by some companies to facilitate it stock on month on month basis in the way that give a margin of certain percentage, above inflation, on the next equivalent fiscal month. Thus making sure that there is always a 12-month budget ahead at all time. Unlike other budget system there is someone to keep an eye on the budget all the time, and when needed fiscal assumption is revised against the following month. Since the budget periods prior to the incremental month just added are not revised, the downside of this approach is that it may not yield a budget that is more achievable than the traditional static budget. (Gowthorpe, C, 2011).

Zero Based Budget on the other hand operate differently, as the name entails it starts from scratch, and do not take into account the previous budget in the sense that any allocation has to be justified. Budgets are planned based on what is needed irrespective of if the cost will be higher or lower than the previous budget.

……………….……………………

This system is believed to minimise waste in business. For illustration, each manager might look at what they anticipate to expend over the next quarter, therefore, each company department head has to defend each phase of their budget for the fiscal period in question. This requires a much more detailed look at each financial transaction and budget need. Many companies are turning to this as a way to stay on top of their financial transactions and eliminate wasteful spending.

With zero-based budgeting, businesses can be extra resourceful with their spending, and come up with the exact amount that they actually need for each fiscal period. Although it is more thorough, it can typically save business ample sum of money in general.

Disadvantages.. though ZBB saves cost it is time consuming in its planning and implementation. It practicality do not favour all department as it benefits mostly revenue generating and production departments of the any business. Because of its detail-oriented nature, zero-based budgeting may be a rolling process done over several years, with only a few functional areas reviewed at a time by managers or group leadership. “Their contributions are more easily justified than in departments such as client service and research and development”. (Investopedia. 2015)

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