Project Finance, Accounting, and Control - Essay Example

?Project Finance, Accounting and Control Table of Contents Annual Budget 3 Weaknesses of the Annual Budget 3 Weak Forecasting Capabilities 4 Insufficient Budget Control of Certain Funds 4 Profitability Index 5 Time Consuming Process 6 Cost 6 Traditional Budgeting 7 Benchmarking 8 Balance Scorecard 9 Activity-Based Models 10 References 12 Bibliography 16 Annual Budget The annual budget is a cautious assessment of the probable income and expenditure that shall take place in the future and is concerned with an accounting period (FMSIS, 2008). The layout of a distinctive annual budget plan comprises a comprehensive line-by-line and department-by-department estimations of the income and expenses which are most likely to arise during organisational operations. Notably, the variables causing income and/or expenses are strongly influenced by the accuracy and the efficacy in executing the budgeting process (Siciliano, 2003). Weaknesses of the Annual Budget The approach of annual budgeting, with the inclusion of multi variables and numerous factors, emerge as a complex process. Consequently, the approach involves many advantages along with few major drawbacks. For instance, there are many shortcomings in the annual budget preparation irrespective to different budgeting approaches. The inherited weaknesses which can be by far identified in the annual budget are discussed below: Weak Forecasting Capabilities The most critical step in the budgeting process is related to the forecasting capabilities regarding the financial resources that will be available in the future course of business operations. Immense technical expertises are required in order to forecast the revenue collection and expenses with high level of accuracy (Martinez-Vazquez, 1997). The level at which the forecasting will be made is a decisive consideration. To initiate the process of budget forecasting there are certain considerations that should be adhered by the executors, i.e. industry-level forecasting, corporate forecasting, product forecasting and product-line forecasting. During the process of budget forecasting, inclusion of all these factors are not considered to be complex, but in turn evolves as a time-consuming process. Consequently, the lack of forecasting capabilities makes the budget risky in executing. In addition to that, different types of problems occur that make the budget restructuring essential and therefore increases the cost (Mentzer & Gomes, n.d.). Insufficient Budget Control of Certain Funds There is lack of control over the budget in regard to certain funds that are variable in nature depending upon the period of operation. The budgeting officer needs to contact each department and analyze the debit and credits of the department in order to find out the funds’ leverage upon the department. Although incorporating this intensive technique, the budget does not have sufficient control over certain funds (New York University, 2007). These funds vary in nature and controlling them within the budgeting process limits is somewhat impossible. This tends to change the overall financial funding. Inclusively, the fund might be internal or external. Pulling the funds for the specified fund option is often misinterpreted as budgeting, which ultimately results to ineffective budget planning. Therefore, the overall planning needs to be re-planed due to the ineffective balance of the funds in the budget. Contextually, the level of control in the fund management in budgeting becomes difficult while drafting the budget for an accounting period (Flexstudy, n.d.). Profitability Index In order to forecast the profitability index, an estimation of the cost of capital is required. But this can not provide the corrective decision when applied to compute mutually exclusive projects (Peterson-Drake, n.d.). The decision may be incorrect while computing and this will result in failure of the budget of the project. The budget model is not capable of determining the profitability index to ensure the effectiveness of the financial status of the company (University of Mississippi, n.d.). Conclusively, it can be stated that the budgeting model to some extent lacks the essential factors to determine the exact profitability index. Due to such errors in the determination of the profitability index of various budgeted projects undertaken, it raises the difficulty in determining the financial plan for the allocation purpose of the projects. In most of the business concerns, the profitability index is quite important. It is necessary as it enhances the financial feasibility and the efficacy of the budgeting approach of a project. Hence, the lacuna in obtaining an effective profitability index shall generate an incorrect report that will negatively effect the business operations (Keown, n.d.). Time Consuming Process The preparation of a budget plan is highly time consuming. It needs to explain the context of each strategic goal that describes its various sub-agencies administrating different programs along with their uneven available resources. It consumes time in providing adequate training for the preparation of the appropriate budget according to the company design. The time consumed in the training process does not guarantee the accurate budget preparation. The process also needs to consider various aspects, such as the departmental budgets and the sub-divisional budgets that increase the accuracy of the plan. But due to the nature of the process which is highly time consuming, hampers the general activities in the normal business operations that ultimately affect the efficacy of the financial operations regarding the fund options (Chan & et. al., 2008). Cost The budgeting is a complex process and certain businesses especially the small ones find that the task of budgeting is too much burden for the company in terms of cost, time and resources with limited benefit. In contrast, most of the corporate executors and financial institutes, such as banks include budgeting in their business plans. But as a general rule the assistance of the budget should exceed the cost. However, there is minimum assurance that the benefit of the budget will surpass the cost and be sufficiently profitable. Moreover, there are certain difficulties in budget forecasting and deriving benefit from it. It is due to the fact that the future period is uncertain with limited resources and unanticipated costs. The process of budgeting is generally executed with expertise team considering the essential elements as time, cost and its accuracy. Certainly, the inaccurate budget production is ineffective for the business planning and control mechanism. In other words, the inaccuracy or the ineffectiveness will increase the cost of the company for the budgeting. In turn, it can negatively affect the financial performance of the company by strongly influencing the cash flow of the company. As a result, there are dysfunctional management affecting the organisational health at large. Additionally, the production department in this case, might be able to achieve extra output from the budgeting framework which can be difficult for the sales department while confirming their targets. This in turn shall add up certain costs to the budgeting process (Osborne, n.d.). Traditional Budgeting The budget is considered as a vital tool to measure and control different organizational operations in order to gain substantial efficacy. However, the budgeting approach has received immense criticism in the recent times, especially the traditional budgeting approach. It is basically due to the fact that traditional approaches are quite ineffective in the modern era of rapid change. This is the reason that forces the organization to re-assess the future and re-align their operational plan and the available resources. There are certain variables assumed in the preparation of traditional budgeting that does not work in recent times. Therefore, the approach has been unsuitable for the modern business. The drawbacks of the traditional approach are evaluated in the further discussions (SAP White Paper, 2001). Benchmarking When the company desires to improve their performance, they create a benchmark. The company compares and measures their policies, practices of budgeting with the high performing budgeting procedures (University of North Texas, 2000). Benchmarking helps in comparing the business with others. But as discussed above the traditional budgeting can not create a benchmark. The assumptions and variables applied in generating the budget has become obsolete in the modern business operations and is an ineffective tool for benchmarking. Consequently, the previous months’ expenses and incomes that have been obtained as the assumptions can not be taken as a benchmark for the following month because those expenses and income might be irrelevant. The benchmarked financial spending and performance might not be effective to determine the future with the similar knowledge and information (Kelly & Rivenbark, 2010). Contextual information related to the company and its products/services are necessary when accessing financial benchmarks that assist to develop a picture of competence that can be applied to generate additional benefit. But with the traditional budgeting technique, it is not possible to derive such additional benefit due to its limitation according to the modern business applications. Another major limitation of traditional budgeting is that it does not differentiate between forecast and goals of the company. Therefore, the forecasts are biased due to certain factors that have greater influential power on the goal negotiation of the company. Due to this there is a huge difference in the committed and the achieved level by the company. This is the reason due to which the traditional budgeting cannot be used as a benchmarking tool for effective measurement of the future prospects (SAP White Paper, 2001). Balance Scorecard According to Kaplan “The BSC retains financial metrics as the ultimate outcome measures for company success, but supplements these with metrics from three additional perspectives – customer, internal process, and learning and growth – that we proposed as the drivers for creating long-term shareholder value” (Kaplan, 2010). In the financial perspective, the budgeting process needs to be centralized and programmed with additional data related to finance such as risk-measurement and cost-benefit data. Along with the financial perspective, the balanced scorecard takes into consideration the customer perception, internal process outlook, modernization and cultural perspective altogether (Kaplan, 2010). This is well illustrated in the chart below Source: (Kaplan, 2010) However, the traditional budgeting technique does not consider these variables as important elements despite of the fact that these factors in recent times are quite essential in gaining a successful growth of the business. Moreover, the traditional method of budgeting does not involve the centralization of data which in turn becomes a problem in accumulating the balanced scorecard technique. Notably, the centralization of data is necessary with an aim to achieve efficiency while considering the balanced scorecard technique. Along with the centralization, mechanization is also required in the process to achieve greater advantage from the financial perspective of budgeting with balanced scorecard technique. The absence of automation in the financial data management in the traditional budgeting does not ensure the effectiveness of the balanced scorecard technique. The risk assessment with cost-benefit analysis is generally conducted in the balanced scorecard technique from the financial perspective but this achievement is not possible with the help of traditional budgeting. Additionally, the approach and the methodologies that are implemented in achieving the objectives of the organization through the application of balance scorecard are also not possible with the traditional budgeting procedure. Even the variables considered in the process and assumptions implied are not applicable for the same level of achievement i.e. through the balance scorecard method (Martinsons et al, 1998). Activity-Based Models The Activity Based Budgeting model is a modern technique that is implied in almost all of the organisations of recent times. The assumptions and the variables that are included in the activity based budgeting are considered to be quite significant in order to gain effective performance and financial stability in turn. The activity based budgeting also considers the cost structure of an organisation. It is implied through the process that are actually being performed and managed more effectively than the traditional budgeting aimed at analyzing the profitability potential of a company (Cokins, 2001). On the other hand, these instances are not possible in the traditional budgeting approach as there are certain restrictions and the assumptions that do not consider the cost structuring of the company. The activity based model provides accurate and relevant information that have the capability to direct the strategies for decision making about the companies pricing, customer relationship, distribution, profitability, and production and employee policy in an effective manner. But on the contrary, the traditional approach of budgeting can not constitute these factors and develop the analysis for the future benefit of the company. Furthermore, obtaining a feasible amount of accurate and reliable data is not possible through the traditional budgeting technique. This is only possible through the implication of modern budgeting technique and one of them is the activity based budgeting approach (Bengu, 2010). The strategic planning and control has been one of the basic requirements of the companies especially associated with production of goods and / or services. It is highly substantial in order to achieve a certain level of competency in the changing environment related to consumer demand and increasing competition. Consequently, with the given characteristics of the traditional budgeting technique, it remains insufficient to meet the above mentioned demands of the modern business. Thus, the requirement of better and advanced budgeting technique is felt that can align the activities of the company like costing, quality management, benchmarking and other important activities aimed at increasing the organisational effectiveness (Marginson et al, 2006). References Bengu, H., 2010. The Role of Activity Based Budgeting on Target Costing Practices. Suleyman Demirel University. http://alumni.spjimr.org/articles/target_costing.pdf (01/24/2011). Chan, S et al, 2008. Budget Formats. San Francisco State University. http://userwww.sfsu.edu/~whh/documents/Team-Budget-Formats-Report.pdf (01/24/2011). Cokins, 2001. Activity-Based Cost Management: An Executive's Guide. John Wiley and Sons. FMSIS, 2008. A Guide to Setting the Annual Budget. IPF. http://www.fmsis.info/uploads/r22.pdf (01/24/2011). Flexstudy, No Date. The Role of Budgeting in Management Planning and Control. How to Plan and Manage Your Company Budget. http://www.flexstudy.com/catalog/schpdf.cfm?coursenum=95075 (01/24/2011). Kaplan, R. S., 2010. Conceptual Foundations of the Balanced Scorecard. Harvard Business School. http://www.hbs.edu/research/pdf/10-074.pdf (01/24/2011). Kelly, J. M. & Rivenbark, W. C., 2010. Performance Budgeting for State and Local Government. M.E. Sharpe. Keown, No Date. Financial Management: Principles and Applications. Pearson Education. Marginson, D et al, 2006. Budgeting and Innovation: Complements or Contradictions? Chartered Institute of Management Accountants. http://www.cimaglobal.com/Documents/Thought_leadership_docs/MigratedDocsMarch2010/Resouces%20(pdfs)/Research%20full%20reports/Budgeting%20and%20innovation%20complements%20or%20contradictions.pdf (01/24/2011). Martinez-Vazquez, J., 1997. Estonia: Financial Management and Budget Process. Georgia State University. http://aysps.gsu.edu/isp/files/ispwp9708.pdf (01/24/2011). Martinsons, M et al, 1998. The Balanced Scorecard: A Foundation for the Strategic Management Of Information Systems. Elsevier Science. http://www.imamu.edu.sa/Scientific_selections/abstracts/Abstract%20%20IT%20%203/The%20balanced%20scorecard%20-%20a%20foundation%20for%20the%20strategic%20management%20of%20information%20systems.pdf (01/24/2011). Mentzer, J. T. & Gomes, R., No Date. Evaluating a Decision Support Forecasting System. University of Tennessee. http://bus.utk.edu/forecasting/articles/evaluating%20a%20decision%20support.pdf (01/24/2011). New York University, 2007. Budget Control Process & Error Report. Financial Information System. http://www.nyu.edu/financial.services/cdv/pdf/cdvbcmwebsummary.pdf (01/24/2011). Osborne., No Date. Budgeting and Budgetary Control. AS Accounting for AQA. http://www.osbornebooks.co.uk/files/af_as_chapter_19_1.pdf (01/24/2011). Peterson-Drake, P., No Date. Advantage and Disadvantage of the Different Capital Budgeting Technique. Florida Atlantic University. http://educ.jmu.edu/~drakepp/principles/module6/advdistable.pdf (01/24/2011). SAP White Paper, 2001. Beyond Budgeting. The Drawbacks of Traditional Budgeting Models. http://www.juergendaum.com/news/beyondbudgeting.pdf (01/24/2011). Siciliano, Gene, 2003. Finance for the Non-Financial Manager. McGraw-Hill Professional. University of Mississippi, No Date. Net Present Value and Other Investment Criteria. Capital Budgeting Technique. http://faculty.bus.olemiss.edu/rvanness/Courses/Fin%20331/Chapter%208.pdf (01/24/2011). University of North Texas, 2000. Benchmarking. Archive. http://govinfo.library.unt.edu/npr/initiati/benchmk/ (01/24/2011). Bibliography Anthony J. Berry et al, 2005. Management Control: Theories, Issues and Performance. Palgrave Macmillan.   David Ashton, 1995. Issues in Management Accounting. Prentice Hall. Malacom Smith, 2005. Performance Measurement and Management: A Strategic Approach to Management Accounting. SAGE Publications. Read More