The Annual Budgetary Process - Essay Example

The Annual Budgetary Process Introduction Before going into making a report addressing critical factors related to budget, let’s get a better understanding of what budget actually is. A budget is the most valuable and effective financial management tool for any organization that lists all planned expenses and revenues. Dayananda, et al., (2002) found that a perfect budget plan includes set of regulations regarding capital to be employed, income, and the expenditure. Budgets should always be prepared and approved by the authorities before the start of the period. The budgets which are approved by the authorities are used by the organizations for various business operations. Budgets are derived from the long-term strategies of any company or organization. Reames (2010) states that “its always important to figure out those areas of your budget where you tend to spend exorbitant amounts or unnecessarily and cut those out”. 2. What is the Annual Budgetary Process? The annual budgetary process is a very lengthy process that takes several weeks in order to develop a valuable plan that is used for the whole year and is not revised until the next year. Peterson and Fabozzi (2002: 245) state that “Annual budgeting is one of the most important, and sometimes most difficult, parts of financing”. It is really helpful for the companies as it lists all planned expenses and revenues for the current year. Annual budgeting process is not just about the budget; it’s also about the growth of the business and performance improvement. Kirk (n.d.) states that “forecasting an annual budget for your business helps you determine where your needs are not only for funding, but personnel as well”. The factors which are needed to be taken into consideration while making an effective budget include the number of budget participants, competency levels, interdepartmental dependencies, diversity of skills, and individual roles. To develop an effective annual budget for a company, following steps are of critical importance: 1. Determining the amount of money which the company has made by gross sales in the previous business year, because that money will be used in order to represent the expenses of the company in percentage form. 2. Estimating the expenses which have occurred in the previous business year. Those expenses include labor expense, water, electricity, advertising, manufacturing, transportation and legal expenses. 3. Dividing the total of each individual expense category by the gross sales in order to express each of the expenses as a percentage of company’s gross sales in the previous business year. 4. Next step is forecasting the company’s expected gross sales for the next year. 5. Multiplying upcoming years projected gross sales volume with the percentage for each expense category in order to estimate the expenses that will be encountered by the company in the coming year as a percentage of the company’s gross sales which will be based on the percentages from the previous business year. 6. The last step is budgeting, which will be done by totaling the expenses and subtracting them from the company’s projected gross sales volume for the upcoming business year. So, these were the steps which are to be taken by the annual budget developing committee of any company or organization. 3. The Objectives of Budgeting A budget plan helps in decision making regarding use of money. Shields (2003) states that “making the initial commitment to live according to your budget is the hardest part”. Budget not only gives a direction for where the money should be spent but also helps in deciding the amount of money to be used in any activity. Budget is always related to that future period for which certain goals have already been laid down by the organization. Let’s talk about some of the core objectives of budgeting: One of the main objectives of budgeting is that it provides valuable information which is used to determine whether current-year revenues were enough to pay for current-year services or not. Budget report also demonstrates whether the resources were obtained and used according to the company’s officially approved budget or not. Budgeting provides valuable information to the managers in order to help them in evaluating the service efforts and costs. With the help of budgeting, appropriate action(s) can be taken by the management of any company or organization regarding any material variances against budget. Budgeting also assists the management in planning and controlling the earnings and expenditures in order achieve maximum profitability for the organization. Budgeting expresses compliance with various finance-related legal and contractual requirements. 3.1. Control Budget is that key which enables an organization taking charge of the finances. With the help of an effective budget, the management of any organization can decide when and what to do with the capital. Lawrence (2004) found that budget gives the control of money to us, instead of letting the money control us. It also helps any individual in getting control of money, instead of getting himself controlled by money. Budget gives us control and guidance over use of money. 3.3. Organization Budget organizes the financial matters in such a way that the funds available for those matters get divided into categories of savings and expenditures. Groppelli and Nikbakht (2000) found that records of all monetary transactions are provided automatically to the management of any company or organization through budgeting. 3.4. Financial Analysis Budget also helps the organization in performing the financial analysis. Through budgeting, management of the organizations can know the financial position of the organization. They can know what is actually going on in terms of capital use for business activities. Budgeting helps in providing the management with the information regarding available capital, current financial position, and future expenditures of the ongoing business activities. 4. The Strengths and Weaknesses of Traditional Budgetary Practices While talking about budgeting, a very dominant type of budgeting is traditional budgeting. Traditional budgeting is based on assessment of the past organizational performance and the projection of findings to the future years with some necessary modifications. During the assessment, if the inflation rate rises, for instance, cost trends of the previous business years are projected forward. But it is projected with various necessary modifications not only for inflation but also for the projected growth or decline in all financial activities. In the past, traditional budgeting was a widely used approach in many organizations because they were not only easy to be put together but also eased the process of coordination of budget assumptions across various departments of the organization. 4.1. Strengths of Traditional Budgeting Traditional budgeting provides ease and simplicity to the management of any organization as it is a very familiar budgeting approach for the persons involved in the budget development process. Its consistency with the line of authorities and responsibility in organizational departments are those factors which distinguish it from other budgeting approaches. This budgeting approach enhances organizational control over various business matters and also allows the accumulation of expenditure at every functional level. Other strengths of traditional budgeting include stability, simple to be operated, easy to be understood by the decision makers, and conflicts do not come when all organizational departments are treated similarly. 4.2. Weaknesses of Traditional Budgeting One of the main criticisms regarding traditional budgeting is that it does not serve the modern organizational needs. Critics complain that budgets are either too long or too short which is not in favor of any organization. They also complain that traditional budgets rely on ineffective measures. There is no balance in traditional budgeting as they are either too complex, shows inflexibility, or too simple in nature. The traditional budgets can never identify inefficiencies and waste. They focus more on the inputs rather than focusing on the outputs which are generated from those inputs. They can neither identify incoming workload nor can they support continuous improvement. Another criticism regarding traditional budgeting is that they present just a little information to the management on the functions and activities of organizational departments. Traditional budgets do not meet the needs of today’s fast-paced business environment as they are extremely time consuming. 5. The behavioral aspects of budgeting If we talk about behavioral aspects of budgeting, we can say that behavioral aspects of budgeting should be given extreme importance in any budget development process. Some of the behavioral aspects of budgeting are as follows: First one of the behavioral aspects of budgeting is that it develops and maintains supportive, caring and cooperative relationship with the members of the staff. The use of punishment by the management of the organization doesn’t mean to discourage the persons involved in the process of budgeting; rather it tends to encourage attempts to beat the system. Another aspect is that it encourages participation in the process of budgeting in order to increase the organizational productivity and satisfaction among the staff. Staff participation in the budgeting process results in improved communication, opportunity to thrash out the problems, improved commitment, and increased acceptance. An important point to be considered is that goals and objectives of individuals and groups should match the goals and objectives of the organization. Goal description is another important behavioral aspect which includes clearly defined goals and particularly agreed and accepted goals. Feedback on performance of the organization must be timely and precise in order to encourage and support success of the financial plan. 6. Relationship between Budgets and Standard Costing While talking about annual budgeting process and its related factors, let’s now discuss the relationship that exists between budgets and standard costing. Tayles (1998) asserts that “budgets and standard costs have similar objectives in that they support planning and control through the isolation of variances”. Budget figures are usually based on actual, budgeted, or standard costs. None of these categories of budget figures are mutually exclusive. A budgeted cost is not always a standard cost even if a standard cost is a budgeted cost. Budgeted cost is the best tool to assess what should be allowed for any new business activity. Standard costing is a very important topic which comes under cost accounting. Standard costs reflect the effective and efficient use of available resources. Standard costing and all related variances are of extreme importance because they can be used as effective management tool. If a variance arises, managements of the organizations become attentive because they get awareness regarding the manufacturing costs as if those costs have differed from the standard costs or not. 7. Conclusion Summing it up, annual budgetary process is of critical importance for any company or organization because it not only helps the organizations in improving current strategies but also sets up the ways to improve future dimensions of the strategies by comparing the past year’s performance and the budgetary performance which results in improved organizational performance and increased productivity. It not only results in increased organizational productivity but also helps the companies in listing all planned expenses and revenues for the current year. References Dayananda, D. et al., 2002. Capital Budgeting: Financial Appraisal of Investment Projects, Cambridge: Cambridge University Press. Groppelli, A. & Nikbakht, E., 2000. Finance, 4th edn, New York, NY: Barron’s Educational Series. Kirk, A n.d., How to Create a Proposed Annual Budget for Your Business, viewed 16 March 2010, Lawrence, J., 2004. The Money Tracker: Find the Cash to Get What You Really Want, Sunnyvale, CA: Advisor Press. Peterson, P. & Fabozzi, F., 2002. Capital Budgeting: Theory and Practice, New York, NY: John Wiley & Sons. Reames, P 2010, How to Develop a Budget and Stick to It, viewed 16 March 2010, Shields, S 2003, Successful Budgeting for Students, viewed 16 March 2010, Tayles, M 1998, Budgetary control - the organizational aspects, viewed 16 March 2010, Read More