Introduction
Budgets are an expression of the plans of an organization. Budgets are prepared for a period of twelve months. This is an import of the traditional way of doing it. The objectives that a company plans to achieve during those months and the resources available for this purpose are included in the budget. The master budget incorporates the mini budgets from all other departments. It indicates the overall direction the company is taking in terms of finances.
The question as to whether budgets are effective has sparked a great debate. There are scholars who propose that budgeting should be abandoned all together. These are the supporters of the beyond budgeting proposal. Some scholars support the idea that budgeting is still an important activity in the modern corporation. This paper seeks to show that despite the shortcomings of the budgeting process, it remains beneficial to organizations today.
Disadvantages of Budgeting
The annual budget has been criticized for being too rigid. This rigidity prevents responsiveness to change, which is critical to success in the modern business world. Resources are allocated to departments once a year and this cannot be altered. The organization in question is likely to miss opportunities that require a reallocation of resources (Jarman and Bibekar, 2009).
Employees who are not involved in the budgeting process are likely to resent the annual budget. They will view the budget as a gadget to police them around. Thus, they will do the bare minimum to comply with this budget. This dysfunctional behaviour could be avoided by eliminating the budget as a whole. Managers also engage in political bargaining for resources in an effort to secure a huge chunk for their departments. They incorporate budgetary slack in order to inflate their budgets. There is also a tendency of increasing the annual budget in order to be seen as the hard working department. This results in misuse and misallocation of resources.
Preparation of the annual budget takes approximately six weeks. During this time, data from the various departments is collated and financial resources allocated as required. This valuable time wasted on the budgeting process could be invested in other core managerial activities. The money invested in the process could also be put to better use within the business. Critics of the annual budget have cited these as major reasons why the annual budget should be scrapped.
The annual budget is usually based on the target sales for the next period. This forms the basis for the production, materials and purchases budget. Thus, the focus is not customer satisfaction, rather, how much the company should sell. This is a skewed perception and is bound to lead to corporate failure. The customer is supreme in any business and should be treated as such.
Managers have their own individual goals. The organization also has its corporate objectives. These two meet in the annual budget. The managers might focus on achieving individual goals in their departmental budgets. This might prove detrimental to the entire organization. Reconciliation of these individual goals and the corporate objectives is quite difficult. This conflict in interests may result in conflict with fellow managers. These disputes are time wasting and bad for company unity.
The figures used in the budgeting process are uncertain estimates. These cannot be verified with certainty as judgement is involved in formulating them. This means that the annual budget is not 100% accurate. This can present a problem to accountants.
Advantages of Budgeting
Budgets guide the organization in planning. It is possible to estimate the expected revenues and expenses with the help of the annual budget. Hence, deficits and surpluses can be identified and arrangements made for supplementary, finance if necessary. The organization’s activities are also coordinated using the annual budget. It is a point of reference for all departments and is the tool that guides inter departmental relationships.
The sales budget governs how much the manufacturing department will produce, the manufacturing budget dictates how much will be purchased by the procurement department. Without the annual budget, departments would most likely be confused in terms of finance. The annual budget also sets out the amount of resources available for that specific period. Thus, individual managers can plan for their departments in line with the budget. It is true that the annual budget aids in goal congruence (Sullivan et al. 2003).
Control entails checking that things are going according to plan and correcting any failures. The annual budget is a useful tool of control. It can be used to enhance areas of the business that are not doing too well by allocating more funds to them. Budgetary control can also be employed to reduce waste of resources in non-core departments. This is important, as it is part of the planning process. Lack of proper control can render even the best of plans useless (Groves and Genever, 2010).
Performance measurement checks outcomes against set criteria. The annual budget is also a tool of performance measurement as it is a criterion in itself. Variance analysis enables companies to know how far they have deviated from their targets. This analysis is not possible without an annual budget. Performance measurement without a budget would be an ad-hoc process that may not add much value to the organization.
The major function of the annual budget is communication. The organization’s plans for the period are expressed in terms of the budget. This forecast can be useful in obtaining funding from banks. It also helps employees to understand which path the company is taking. Good communication ensures their commitment and improved performance (Sullivan et al. 2003).
Conclusion
Budgets are useful to financial managers as well as non-financial managers. The financial crisis rendered many previous year budgets obsolete. This was due to the rapid downturn of financial markets. However, there are new budgeting techniques that are useful to managers in rapidly changing circumstances. The rolling budget which is updated frequently is the most suitable tool in this situation. This budget is updated quarterly and is usually up to date with the goings on. Managers can also employ flexible budgets which can be changed depending on the economic environment. This kind of budget can be prepared in triplicate, each copy reflecting a different set of circumstances (Groves and Genever, 2010).
Critics of the annual budget have claimed that it encourages slack. This can be eliminated by employing zero-based budgeting. ZBB would require managers to justify every expenditure item. This encourages accountability. It is true that the traditional budgeting process has its flaws and may not be relevant to today’s modern business world. However, reality is that the annual budget cannot be done away with in entirety. Companies that wish to benefit from this tool of management must adapt to the new techniques that make the budget suitable to their situations. This way, they will enjoy the full benefits of having an annual budget.
Reference List
Groves, N. & Genever, A. (2010) Budgeting After the Crunch. ACCA Accounting and Business, 1: 40-42.
Jarman, N. & Bibekar, S. (2009) New Era Budgeting. ACCA Accounting and Business, 1: 46-47.
Sullivan, A. et al. (2003) Economics: Principles In Action. Upper Saddle River, New Jersey: Pearson Prentice Hall.