Budget is intended to control the general finance of companies in regard to the fiscal year, but can be arranged into quarterly, monthly and yearly 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. Budgets tend to identify areas where the need to spend more or less is. The financial plan is prepared in advance and then equated with real performance to establish any differences.
Reasons for budgeting can be five-fold: ORGANISATION, CONTROL, HABIT, and 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 is 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 situation (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.
Though many other reasons could be added, like control of income and expenditure, provision direction and co-ordination, so that corporate objectives can be turned into practical reality, it gives responsibilities to those with the task of implementing it by allocating the required resources. Through budgeting, there are frequent communications between business stake holders to staff in regard to set targets.
Budgets can act as tools in motivating staff to achieve certain targets set by the management, and when this target are met then it brings about proficiency. It is also used in monitoring performance level within the company in all departmental level.
Whilst there are many uses of budgets, there are a set of managerial ethics for good budgetary mechanism in a business. Implementation of budget is the full responsibility of the department managers who has to make sure the budget is applied prudently. Individual budgets lay down a plan of action that needs to be adhering to by all concerned. And while strict performance is adhering to, the budget monitored for good performance, and when and if the anticipated result is not achieved a remedial action is taken, it thus gives possibility for scrutiny if there are any unexplained changes. Only member of the senior management can authorise any variation from the, budgets subject to approval. (Tutor2u. 2015).
Typically, budgets can be broken down into three major uses of Coordinating, Planning and Controlling, which in turn makes sure there is no unnecessary wastage and everything is accounted for.
There are different types of budgets; but for this of the assignment I will be focusing on INCREMENTAL BUDGET. This type of 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 a starting point has been determined, any department needs more money than the previous budget, then they have to be able to explain the extra expenses, and also, if you do not use your budget, then the next period’s budget is likely to be reduced. This type of budgeting often leads to inefficient 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 budgeting are that they are 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 is relatively simple and straightforward. This method has the benefit of generating budgets that are comparatively stable, with gradual changes from year to year.
Some of the disadvantages of incremental budgeting are 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 finance stages, even in cases where the funding is highly extraordinary 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 is 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 tend to overestimate 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.
Businesses have evolved over the years, in that most business are now big corporation and not a one-man enterprise, hence they have to accept that their very profitable existence is co-dependant on what service is provided to the general public. Before the introduction of modern day budgeting systems business tend to take their income generation serious by not adhering to strict budgeting rules. With budgeting businesses tend to within the confine of what they can afford, as there is no unilateral spending by any individual.
In order to generate revenue, business tend to plan and articulate the margin they can reach in order to make enough profit to sustain their business; this can be achieved through budget in as much that a company going into deficit has not been able to manage its budget well.
PART TWO:
In recent years some business has formulated alternative budgeting systems 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 have 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 gives it 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 (ZBB) 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 business head 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 budgetary 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. Its assistances are supplementary and are certainly justified than in sections such as client service and research and development departments. Because of its detailed nature, zero-based budgeting may be mastered over several years due to its rolling process, with only a few functional areas reviewed at a time by managers or by those in control budget planning. (Investopedia. 2015)
Ability-Based Budget (ABB) on the other hand gives businesses the opportunity to appraise each period of the budget and take action on what is needed in getting the right productivity. Activities are then tied to planned goals, after which the expenditures of the activities needed are used to create the budget and this achieved after the expenditure of the business are recorded and analysed, and all functions defined.
Activity-Based Budget has its benefit which includes its ability to make all the manager and staff to look at the business as a whole and not from a departmental point of view. With this focal point, the staffs sees themselves as a service provider which in turn will lead to customer satisfaction, and enable the management to realise what is most important for their business thus helping in making a proper strategic planning.
As it facilitates positive scrutiny of the business, rivalries between managers and their various departments are virtually eliminated, money is saved after recognising and removing unnecessary expenditures and the saved money is then used for future projects and new products. Restricted access that slow down the far-reaching progression of the business can be recognized and removed.
Some of the disadvantage of ABB is the fact that its implementation requires special programme, in this days of technology. Special software has been written which require that any company willing to use or implement this system of budgeting will have to purchase it. Unlike other budgeting system the business does not need to buy an expensive software licence and special training.
When this software is installed, the company have to take the necessary step of having managers and other needed staff to carefully trained so as to be able to understand how it works since no one will understand the system so easily. For it to work all departmental head have to understand the procedure. And with the knowledge the company’s budget will not be properly implemented which will in turn lead to wrong feedback from each department.
If managers do not understand Activity-Based Budget, they will not be able to know where all their money goes and how it is used, then the budget process will not be effective in its implementation hence it requires all those involved to deeply comprehend it; and as such each manager has to be focused on theirs budget and its evaluation.
This particular budget tends to make managers lose focus on what they are good at in their respective department as most of them do not have accounting knowledge but are required to deal with the accounting in regard to implementing the budget, simply because they did not get to their current position with accounting knowledge, but with this process, companies will have to depend on these managers to engage in the activity-based budgeting process.
“This can sometimes make them lose focus on what is actually important. They will be so focused on coming up with the budget that they will not spend enough time engaging in activities that are actually profitable for your business. In some cases, this can lead to lost revenue and unproductive work sessions for these respective departments. In most cases, it is better to allow the individuals that are in charge of the company to handle budgeting and not department managers”. (Financial Web. 2011)
Conclusion:
It is essential in preparing for budget for a firm to set out its aim for the year by so doing the business will achieve its objectives and this can be aided by doing the following:
- To control income and expenditure.
- Establish priorities and set targets in numerical terms.
- Provide direction and coordination so that business objectives can be turned into practical reality.
- Assign responsibility to various departments (an agreement to allocate resources)
- Communicating targets from management to employees.
- Motivate staff into performance and sense of belongings.
- Monitor performance as preparation for the budgets is not enough. It must serve to meet its intended purpose, whether production, sales and/or expenditure.
Budgets need to have four element before it could be utilised; and this four components determines the success of failure of the budget. These are Planning, Measurement, Comparison and Control.
- Planning: to implement a budget one need to plan for it. The business need to have a scale of preference (on what to buy and spend on that are important to the business), the amount to spend on income has to be included in the planning stage. Attention has to be paid to all details that are of importance in the business otherwise there will be a deficit in the course of the fiscal year.
- Measurement: this is the aspect where the guidelines are given to various managers of departments, as soon as the final budget is reached. The measurement is achieved when each sections spend its fiscal provision within the stated budget demand. The financial success and viability of a business depends largely on its ability maintain and work within its budget.
- Comparison: as time goes on the company need to access its budget against its spending for that fiscal period; and by so doing will be able to determine where there are shortfalls (if there is an action is taken to redeem it).
- Control: this is the action taken in regard to how finances are utilised. Such action could be to take full control of any department that are under-performing. All spending that is conducted according to the annual budget document helps a firm maintain its focus on strategic goals. (Audra Bianca. 2014)
It should be noted that some businesses tend to set budget targets. By setting target the threshold for the budget can be achieved but in some cases such target are unrealistic hence will be a burden on the mangers. This could lead to staffs being unscrupulous in their dealing with others or the larger public as they tend to protect their position within the firm.
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 interconnected. In principle, the economic consideration indicates that the budget has some functions such as in allocation, sharing and equilibrium. Besides that, budget helps in the valuation of the fiscal 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 departments with regard to achieving the company’s arrangements toward its fiscal and financial 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 bestride 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; and budget applications albeit successful. Irrespective of how difficult it is to understand, budget is still and integral part of business day to day activities.