Key Stages of Budgetary Process - Essay Example

Finance and Accounting Describe the key stages of budgetary process, (b) critically evaluate, referring to the research findings the social significance of budgeting in modern organisations? Contents Contents 2 Introduction 3 Key Stages of Budgetary Process 4 Communicating the detail information about the guidelines and policy of the budget 4 Deciding the factors that restricts the output 5 Construction of Sales Budget 5 Initial Preparation of other budgets 5 Negotiation about the budget with superiors 6 Coordination and review 6 Final Acceptance of the budget 7 Continuous review of the budget 7 The social significance of budgeting in modern organisations 8 Conclusion 11 References 13 Bibliography 14 Introduction Budget can be defined as a plan which can be expressed in monetary terms and covers a specific time period generally a year. Budget is created with the help of previous decisions. It can be stated as a quantitative description of a plan for a specific period of time. It includes standard volume of sales and revenues, assets, expenses, liabilities and cash flow. It shows the strategic planning of the business firm. Budgeting helps the company to compare between the standard and actual revenues and production capacity of the company. Budget is influenced by the past experience and the past experience has an impact on the future budgetary process (Fiu, No date). Budgeting process can be done for several reasons in an organization like planning, communication, coordination, motivation, performance evaluation and controlling process. Budgets can be of various types like short term budgets which are done for a month, a quarter or for a year. Operational control budgets are mainly done for a specific operation and the duration of this type of budget is a week or maximum a month. The most long term budget is known as capital budget which is done by the company for a period of more than one year and it can be extended to ten years and it determines that whether a company should proceed for a long term investment or not . Budgets can also be differentiated as sales budget which estimates the amount of future sales revenue and create a target for sales, production budget which estimates the number of output that should be produced to meet they sales target. Marketing budgets help to estimate the amount which is necessary for advertising and promotional activities to place the product in the market (Collier, 2002, pp. 207-208). Key Stages of Budgetary Process Budgets are mainly based on the standard costing method for a certain level of production and sales. It should be prepared by an experienced accountant. A budget should describe the objective of the budget and the steps that are involved in the process of budget. There are several steps involved in the budgeting process which area s follows- The main important step is to communicate the detail information about the policy and guidelines of the budget with the people who are responsible for preparing the budget for the organization. Then the factor those restricts the output should be determined. The sales budget should be prepared. Then it should prepare different types of budget. The next step is to negotiate about the budgets with the seniors. Proper coordination and review of the budget should be done. Final acceptance of the budget. After that continuous review and rechecking of the budgets should be done. Communicating the detail information about the guidelines and policy of the budget Communication about the guidelines and policies with those people who making the budget is very important because e many decisions that may affect the budget year have been considered previously in the long term planning process which is the starting point for the annual budget. Thus the top level managers need to communicate the effect of the policy to the people who are responsible for the preparation of the budget of current year. The effect of the policy includes changes in plan of sales or contraction or expansion in certain business activities. Apart from this, other necessary guidelines which are useful in budget preparation should be mentioned clearly. Along with this if there are any changes in the demand and output of the product then it should conveyed by the top managers to the managers who are responsible in monitoring the budget preparation. It is necessary that all managers should get information about the policy of the budget by the top management for it in the present year’s budget to confirm that common guidelines are set for the current year. It also indicates that how the managers are reacting to the environmental changes (Drury, 2008). Deciding the factors that restricts the output In every company there are some factors which restrict the output of the company for a certain period of time. It has been seen that in maximum organization the main factor is the demand for sales. However the production department can restrict the performance when the sales demand crosses the level of capacity of the organization. Thus before preparing the budget it is necessary for the top managers to determine the factors that have an impact on the performance of these factors decide the point at which the budgeting process for that year should begin (Drury, 2008). Construction of Sales Budget The level of the operation of a business organization depends on the volume of sales mix and sales. Thus it is one of the most important parts of the annual budgeting procedure. But at the same time it also the most difficult to prepare this budget as the total sales revenue depends on the purchasing pattern of the customers. Apart from this, sales demand may be affected by the economical condition and the action of the competitors (Drury, 2008). Initial Preparation of other budgets The responsible managers who are in charge of meeting the performance of the budget should prepare budget for their own areas or departments also. Preparation of budget is also known as a bottom up process which means that preparation of budget should be started form the lowest level of management and then it should be coordinated and refined at the higher levels of management. The need for this approach is that it helps the managers to participate actively in the preparation of the budgets and increase the profitability of the company as the managers will accept the budget and work hard to achieve the target. There is no certain way in which the standard quantity of the items of a budget can be determined. Thus previous data can be used at the starting point of the budget. If there is any further change in the future then it should be taken into account but past information provides necessary guidelines for the future. Along with this, managers can also take help from the top managers for determining the amount of the budget (Drury, 2008). Negotiation about the budget with superiors The budget should be generated from the lower level of management in order to get the participation from all level of management. The lower of managers should prepare and submit their budget for the approval process to their seniors. The seniors should integrate this budget with other budgets which he /she has made and send it to his/her superior for approval. The next superior then becomes the budgetee at that level. Thus this process states it is a two way process in which budget preparation flows from bottom of the organization to the top and approval of the budget flows from top of the organization to the bottom. Thus negotiation of the budget flows from the bottom level of the organization to the top of the organization in which lower level managers prepare the budget and try to convince the superiors about the budget (Drury, 2008). Coordination and review When the bottom level managers prepare a budget and send it to the superiors then it is the responsibility of the superiors to coordinate with the lower level managers and review their budget preparation and if some corrective action is needed to be done then they should review the budget and send it to their seniors for the approval. Thus preparation of the budget starts from the lowest level of management and then coordination and review of the budget continues to the top level management of the organization (Drury, 2008). Final Acceptance of the budget When all the budgets are matching with each other and they create a satisfactory position for the organization then the budgets can be summarized in to a main budget which consists of profit and loss account, cash flow and balance sheet for the budget. When the master budget gets prepared and accepted by all then it passes through all the departments of the organization and reaches the main responsible centers. The approval of this main budget is depending on the manager of each department and they need to carry out the plans attached with each budget (Drury, 2008). Continuous review of the budget The budget process is not complete even after the budget is approved because in after every certain period of time actual output should be compared with the standard budgeted result. This should be done on every month and the report should be sent to every budgetee in the first week of that month in order to motivate the managers. It will actually help the managers to identify the factors those are not going according to the plan and they will be able to investigate the reasons behind it. If the factors are within the control of the managers then necessary action can be taken to avoid the inefficiencies in future. Thus the budgetary process does not complete for the present year as it gets approved but it should be seen as a dynamic and continuous process (Drury, 2008). The social significance of budgeting in modern organisations The success of an organization in controlling its activities depends upon the actions of managers that whether they are appreciating the importance of good interpersonal relationships between all departments and all levels in the organization or not. Accounting managers can motivate other employees through the budget procedure and can improve the attitude among the managers in every department to control the budget more efficiently. According to Otley, the reward that can be gained by achieving the target of the budget is helpful for motivating the lower level managers and employees. There are some behavioral issues attached with the budgetary reporting system and it includes issues related to budgetary control and standard costing. Behavioral issues of budgets can be defined as their impact on the efficiency of managers of the organization to achieve their goals. Budget of any company has double role, one is to forecast the expenses and income of the year and another is to measure the performance of the management. Budget can also be used as a tool to control the managerial performance. Budgetary control is also associated with Managerial and Organizational goals, developing process of budgets and the method of reporting and evaluation. Successful controlling system of an organization depends on the efficiency of top management and their excellent inter personal relationships among different levels of hierarchy in the organization. Managements can motivate the employees through the budget process and can develop the attitude amongst managers towards budgetary control. There should be reward on fulfilling the target of the budget which will encourage and motivate the lower level managers and employees. There are mainly three type of approaches which can be employed to prepare the final budget and these are as follows- a. Imposed budget- it is the type of budget which supports the autocratic style of leadership. It is also known as top down budget as the top management only has the right to decide the budget and lower management only executes it. b. Participative budget- it is the type of budget which supports the democratic style of leadership and also known as the bottom up budget. Here lower management also contributes and put their opinion on the budget. c. Negotiated budget- it is the type of budget which combines both imposed and participative budget and it creates a situation where every level of management has equal responsibility to the budget preparation. Negotiated budget is helpful for an organization as it includes the participation from every department of the organization. According to Glautier, among the above approaches the approach that will be chosen will depend on the leadership style of the company. It has been seen that the budgets which have been made using participative and negotiated approach are getting better support from managers and workers (Raghunandan, 2012, pp. 112-114). According to some other view, traditional budgeting system acts on the company’s growth and the creativity of the employees. It also prevents the employees from communicating with customers. It states that in this current environment firms need more flexible and responsive system to deal with the sudden changes market and demand of the customers and increasing competition among competitors. According to Lindsay, it requires more efficient management skills to solve budget related issues. Along with this, active participation from workers in managerial activities enhances the job result and encourages the employees. According to Banham, in a CFO Europe survey in 1998, 88% of the total participants told that they were not satisfied with the present budgeting model in their organization. It has been seen that in many cases, legislation has given idea to the managerial activities, research has enhanced the business operations and advance technology has changed the way of managing, conducting the business activities. This can be considered as the most prominent way beyond the budgetary system. According to Norton, the value of budgeting system has declined and it is adding less value than pervious. The annual budget also suffers from some problems. According to Hope and Fraser, the functional budget was helpful for accounting model of management as it had control, hierarchy and focus on command during the industrial age. But in today’s information age it is not be able to meet the challenges of current market scenario. If a closer view can be taken about different opinio9n of different people about annual budget then it can be seen that according to Hope it encourages incremental thinking process and rigid planning system. According to Schmidt, budgeting system in modern organization is very much time consuming and it is unable to how the changes that are taking place in the operations and processes of the organization. Sometimes budgeting system also produces inadequate reports for variance analysis by leaving the why and how questions unanswered and it also draws shareholders’ attention on the short term financial results which gives a picture to the shareholders that the organization is not able to take risk and cannot give security. As it is rigid yearly ritual which is carried out by the accounts department on every year thus it is unable to indicate the changes that are taking place in the competitive environment. It binds the organization into a 12 months obligation which can be proved as a risky situation because the company needs to go through many uncertain situations in a year. Thus failure of such commitment or contracts can be seen as barrier and constraint in the competitive ability of the organization. Apart from the criticism of the annual budgeting system, the budgeting has some significance role in an organization. According to the residual earnings model of Ohlson, the total value of the company is equal to its net asset value and the present value of return on equity and the present value of return on equity should exceed the current rate of return and systematic risk of the company. Thus the budgeting system can be seen from dual side. One side can argue that traditional budgeting system is an important tool for maintain the effectiveness and efficiencies of the internal management which in future will help to balance the equilibrium value of the company. But on the other side, many researchers have stated that traditional budgeting system is not able to add any value to the external effectiveness of the organization. As it has been seen that in this modern era of globalization, strategies which are created by based only on the internal efficiencies of the organization are not able to add any significant amount of value in the output thus traditional budgeting system has lost its value in modern organizations. The only remaining role that budgeting system is having that it can be considered as a tool to measure the effectiveness of the managers towards achieving the organizational goal. Conclusion From the above study, it can be seen that budgeting system is tough and complex procedure and the optimum result can only be obtained when a mix of factors is taken into consideration. There are some important factors that cannot be avoided like nature of the participants in budgetary process, type of the budget, degree of uncertainty in the market as these are necessary factors in the process of budget preparation. Excellent communication skills among managers and accountants are necessary to discuss all these factors and implement these factors in real situation. Budget cannot be used as a tool to improve performance or the increase the output but it can be set to measure the difference between the standard output and the actual output (Raghunandan, 2012, p.116). As discussed above the preparation of budgetary system should go through different stages in an organization to form a perfect budget based on current market scenario. The preparation of budgeting system should start from the bottom level of the organization and it should flow to the top level management. In the first step of budget preparation, bottom level managers prepare the initial budget for their field of operation and then they send it to their superiors for approval. The superiors then check the budget and send it to their superior. In this way the budgets reach the top level management and top level management then review the budget and approve it. On one hand budgeting system builds the communication between all levels of management. But on the other hand management should realize that budgeting system has some significant behavioral issues and managers are responsible to minimize the issues related to budgeting system to control the problematic situations. It can be said that accountants and participants of budgetary system should improve the communication with behavioral specialist scientists to understand the essential role of human behavior in successful budget preparation. Thus it can be seen that like other accounting systems, budget also has some pros and cons in it. The organization needs to use the budgetary system in its favor to motivate the employees and managers at all level rather than focusing on the behavioral issues side of the budgetary system. References Drury, C., 2008. Management and Cost Accounting. UK: Cengage Leraning EMEA. Raghunandan, M., et al., 2012. Examining the Behavioural Aspects of Budgeting with particular emphasis on Public Sector/Service Budgets. USA: International Journal of Business and Social Science. Fiu., No Date. Public Budgeting and Financial Management. [Online]. Available at : http://www2.fiu.edu/~ganapati/3003/budget.html. [Accessed on March 14, 2014]. Collier, P., 2012. Accounting for Managers. [Pdf]. Available at : http://iclass.iuea.ac.ug/intranet/E-books/ACCOUNTING%20%26%20FINANCE/Accounting_for_Managers_-_Interpreting_Accounting_Informatio.pdf. [Accessed on March 14, 2014]. Bibliography International Budget Partnership., 2014. Steps in the Budget Cycle. [Online]. Available at : http://internationalbudget.org/getting-started/why-are-budgets-important/steps-budget-cycle/. [Accessed on March 14, 2014]. Bhimani, A., et al., 2012. Management and Cost Accounting (5th edition). UK: Prentice-Hall. Read More