The Importance of Budgeting to Organizations and the Application of Some Budgeting Principles - Essay Example

The Importance of Budgeting to Organizations and the Application of some Budgeting Principles 1. Introduction This paper seeks to prepare a report about the importance of budgeting organizations and how budget should be linked to realistic plans and strategies using the case of Oriole Furniture to illustrate arguments and how would the Rattan Furniture Division apply budgeting principles to reach its year end budget 2. Findings/analysis 2.1. Report to Mr. Mente on the importance of budgeting to organizations and how budget should be linked to realistic plans and strategies and using Furniture case to illustrate arguments (50%). To be able to realize the importance of budgeting to organizations is to answer the question: “Is it possible for the organizations to operate without an appropriate budgeting system?1” The answer to the question is of course, no. I believe it is impossible to have no plan. An organization must have a purpose and no matter how one puts it, it will have to have a plan and that plan will necessarily require a budget, which is the equivalent of a financial plan. A unique case was shown by Hope, J. and Fraser, R.2 involving a Swedish bank by the name of Svenska Handelsbanken, which had operated without annual plans or performance contracts for around thirty years. In said case, the authors mentioned the lack of plans or performance contracts. However, their report was talking about low bad debts, low transaction costs through use of telephone and internet banking. From these set of facts, this paper believes that the report still has the characteristic of a budgeting and no matter how one would term it, there is an element of financial information and therefore, budget is still indispensable. From the concept of ‘beyond budgeting’, there is still the word “budget”; hence one could not logically argue that budgeting is not necessary these days. Hence, it is still maintained that it is impracticable and absurd to operate without at least a plan. If ever an organization will opt not to have one, it would be difficult to conceptualize what the consequences are. The next follow-up question would be: “Is it worth of spending time and money on planning & implementing a budgeting system?3” Our answer therefore to this question is yes as a matter of logic. It is worth spending time and money to plan and implement a budget system. A budget takes the form of a commitment of resources in the future and one could hold people still to plans is an important purpose to remember. Hence, it must be provided attention and time to really bind the people who will implement the plan. A human being has a dream, which is actually a piece of action plan. So with an organization, it needs to have a plan to chart its future even in the short run. The alternative is day to day operation without knowing what to do in future. A kind of budgeting is the so called capital budgeting where is the used of discounted cash flows4. If this is not done, the business will never know whether a business proposition would be properly evaluated. Capital budgeting is almost reality of any investor. On would not simply go into business today and sell it tomorrow. There must be an element of things in the future. Moreover, as a rule we humans endeavors to accomplish something which needs to be done tomorrow, hence the necessity of planning which could actually be best supported by a budget. Are there budgeting techniques that could help organizations? To answer the question, Neely, Bourne and Adams5 enumerated better budgeting techniques which include activity based and zero based value based, profit wheel and rolling budgets. In explaining the terms activity based, the authors said activity based “involves planning and controlling along the lines of value-adding activities and processes”6 while a zero base is meant to “avoid building on the inefficiencies and inaccuracies of previous history7.” In value based, there is treatment of all expenditure plans evaluated as project appraisals and assessed in terms of the shareholder value they will create, while in profit wheel, there is assessment whether an organization or unit generates sufficient cash, creates economic value and attracts sufficient financial resources for investment. Rolling budgets are claimed to be more responsive to changing circumstances, but they require permanent resource to administer.8 As to how budget should be linked to realistic plans and strategies, it could be said that budget as short term financial plan could be used to control the current operation by making it sure that departments should work within their targets. Budgets connote commitments from manager to stick to plans, hence these managers could be held responsible for not functioning as planned. Using the furniture case to illustrate arguments, we could say that Mr. Mensan, the Company president effectively got the nod of Mr. Mente, although the latter was not sure to produce the level of revenue as indicated in the plan. Given the importance of the budget in controlling the operation it has its own limitations which must be accepted. 2.2. What actions should the Rattan Furniture division might take mid-year to help ensure the company reaches its budget by year-end. (30%) Rattan division is having a problem to meets it budget at year end because of poor economic conditions9 despite the fact of working hard by sales people. Case facts confirmed which state: “Mente knew his sales people were working harder than ever and he believed they were doing a good job in view of the poor economic picture. Improving sales would not be easy—if it could be dome at all.10” Economic conditions affect the demand for company’s products. Poor economic conditions could mean low purchasing power of consumers or high inflation rate or higher interest rates for borrowing. This a factor external to the company so that no matter how hard one wants to sell if the buyers simply do not have the purchasing power or they have better priorities because of the economic difficulties, then any effort by the management of Oriole could not just force demand to increase as what happened in prior years. Since the budget is made to prepare the a profit plan which means that it consists of a plan for expenditure and a plan for expenses it follows that if one could increase the economic conditions one could at least minimize the expenses to still meet the profit target. And this is the contemplated option of Mr. Mente who was forced to agree with the Mr. Mensan, the company president for revised and increased budget for the year despite the poor economic condition. Mr. Mente’s choices included not to purchase the equipment or not to hire furniture designers. These options are confirmed by case facts which provide: “One idea he has contemplating was to delay the purchase of some new machinery and which was scheduled for delivery in September. This machinery, which cost $500,000, would replace some existing machinery which broke down frequently and led overtime labour, and sometimes late delivery schedules. Another possibility he thought of was to forego hiring two new furniture designers, this would save about $ 100,000 in salary for the rest of the year.11” What could be noticed from the choices left to Mr. Mente are the consequences of implementing that decision. If equipment would not be purchased, this could again result to overtime labour and late delivery schedules. If such things will happen, cost will also increase and revenues12 could even further decrease because of unsatisfied customers brought by late delivery of products completed. The other option of foregoing the hiring of fashion designers could also result to products that lack innovation or poor creativity which could redound also to poor sales and therefore poor revenues and poorer profits13. It is actually a dilemma and which the profit planning served by budgeting could not simply address. At this point, it would best to recognize that there are limitations to budgeting that must be acknowledged. Some cost may be controllable that one could be faulted to make the wrong decision but on other hand, some cost just need to be spent no matter what the situation may be. In the latter case, one could not sacrifice the essentials which requires spending whether organization likes it or not because failure to do would bring the same result of not meeting the objective or it could be worst than intended because of less sales due to lack of equipment to process products or lack of people to improve creativity. Although Mr. Mensan’s statement attitude is laudable that he still expected to reach the profit objective set for the year by saying that the company has been successful for the past 20 years, there must also be a point where he needs to be realistic. Hence his statement that, “Over the years, our profit plans have helped in achieving our success. They tell us where we want to go and how we will get there. It’s tough sometimes, and that is when we have to buckle down and plow ahead.14” may no longer hold because conditions change. Case facts say that he “had no experience in managing during a slowdown in sales15” makes it understandable to make those statements and so he finds it difficult to be sticking to budget plan when conditions have changed. He must therefore be flexible and adjust the budget accordingly. 3. Conclusion: Budget is traditional requirement for planning and purpose and it is one of those prepared by management accountant so that the purpose that these budget serves Professor Sizer16 has no reason to call these accountants unresponsive. Budgets are just plans which mean that the plan may or may not materialize. Although they could be effective in controlling operations, they need not be unnecessarily rigid and inflexible when conditions change. 4. Recommendation President Mensan therefore under the facts given in the case should be flexible in meeting its target. He could not force the furniture division to meet its target if a condition beyond its control is involved. He should demand responsibility only for those acts that are controllable. When external conditions change plans must also exchange. There is truth in the saying that one cannot extract blood from water. Mr. Mensan should only use the budget as means to accomplish an end but never the end itself by trying to force its accomplishment when it has become unattainable due to changed conditions. 5. Bibliography Abdel-Kader, M. G. & Dugdale, D. (1998), “Investment in Advanced Manufacturing Technology: A Study of Practice in Large U.K. Companies”, Management Accounting Research, Vol. 9, No. 3, pp. 261-284 Allen, B.R., et. al. , (2005) Cases is Management Accounting and Control Systems, 4th edition, Pearson Education, New Jersey Anthony, Reece and Hertenstein, (1994), Accounting Text and Cases, IRWIN, London, United Kingdom Anthony, Reece and Hertenstein, (1994), Accounting Text and Cases, IRWIN, London, United Kingdom Hope, J. and Fraser, R. (2001) Beyond Budgeting Questions and Answers (2001), CAM-I, London, UK Meigs and Meigs (1995), McGraw-Hill, Inc. London, United Kingdom Neely. A, Bourne. M, and Adams, C (2003), better budgeting and Beyond Budgeting Measuring Business Excellence, Vo. 7 No. 3, 2003 Samuelson and Nordhaus (1992), Economics, Fourteenth Edition, McGraw-Hill, Inc. London, UK Sizer, J. (1989) An Insight into Management Accounting, Penguin Books, UK Read More