Concepts of Budgeting - Coursework Example

INTRODUCTION A budget is as interesting to the maker as to the user. The person preparing a budget could also be its end-user. But for big corporations, budgeting is an intricate process from inception to consummation. Senior management is always on the look out for any deviations that arise due to changes in the competitive environment. A budget possesses different definitions depending on the user. For an accountant, a budget is “a summary statement of plans expressed in quantitative terms; it guides individuals or an accounting entity in reaching financial or operational goals.” (Meigs et.al, 1977: 925) For a financial consultant, a budget is basically a plan which enables the user to do three (3) important things: 1. ensure enough money for future activities; 2. control and monitor finances of the business; 3. extract information to enable growth and direction. For a marketing executive, budgets are used “to plan what their companies are going to do in order to provide control over various functions.” (McCarthy, 1975:542) Budgets assist in the marketing executives in making decisions regarding their products, pricing strategies, promotional efforts, place specifications and other strategic decisions over the coming fiscal year. For an ordinary mother, a budget is a tool which assists her in computing the items which need to be paid given a certain amount of cash in hand. She has to consider day to day expenses as well as monthly bills. The budget is an important guide that would give her the opportunity to plan on future investments or leisure activities of the family. THE PURPOSE OF BUDGETING From the definitions given, it can be deduced that individuals and corporations create a budget to assist them in two (2) important facets of endeavor: (1) planning and (2) control. With the use of a budget, corporations and individuals will be able to plan given the resources and the market factors that interplay in the environment. A budget would guide them in making important business decisions with regard to their products or services and with the capital and human resources available. The control function is of equal importance because a budget enables the business entity to monitor and apply corrective action. Budgets also provide a means to evaluate performance. However, the effectiveness of a budget depends largely on the human factor in the company who implements and ensures its success. BASIC BUDGETING CONCEPTS Budget Period A budget is prepared several months before the onset of a company’s fiscal year. For some companies, a budget is prepared one quarter before the start of a new operating cycle. Although there is no fixed rule, in general, Meigs et.al., (1977:926), noted that “the period covered by a budget should be long enough to show the effect of managerial policies but short enough so that estimates can be made with reasonable accuracy”. Kinds of Budget A budget could be very simple to a mother but it could be detailed and precise for an auditor or for management’s perusal. Due to the intricacies of the most exhaustive budget, it is best to identify the kinds of budget and associate the purposes of each. Meigs et.al., (1977:926 – 927) presented the different kinds of budget as follows: a. Master Budget is an overall financial and operating plan for a forthcoming fiscal period and the coordinated program for achieving the plan. b. Capital Budgets are long range budgets which incorporate plans for major expenditures which cover plans for as long as 5 to 10 years. c. Responsibility Budgets are often prepared monthly and are segments of the master budget relating to the aspect of the business that is the responsibility of a particular manager. d. Cash Budgets are day-to-day plans for cash collections and payments of a particular company. e. Continuous Budgets are plans which are constantly reviewed and updated. f. Time Budgets are plans for effective use of a person’s time expressed in days or hours. g. Expenditure Budgets are plans for spending available money for a particular period. Whatever budget one uses, it definitely serves a purpose for a time stipulated. The kind of budget is tailored to the needs of the end-user who ultimately requires its preparation. Elements of a Budget Villegas (2006) identified three (3) basic elements of a budget. These are (1) Sales Revenues; (2) Total Costs and (3) Profit. Sales Revenue. Miegs et.al., (1977:77) defined revenue as “the price of goods sold and services rendered to customers.” This is an important element in a budgeting process because this determines the amount of expenses or costs which can be absorbed or paid by the company’s operations. Budgeting for revenues can be done using the past financial performance of the company. A factor could be included to account for expected increases or decreases in sales due to other relevant market factors. Total Cost. Details from Cost Definition defines cost as “the total money, time and resources associated with a purchase or activity.” For some, computations for costs are more complicated because a lot of factors are taken into consideration. For one, costs are either direct or variable. Further, different costs may be useful depending on different purposes. Profit. Webster, (2000:514) defines profit as “financial gain, especially the sum remaining after deducting costs from the revenue.” This is usually the bottom line in an income statement. Management would like to be apprised of the income the business would generate after all expenses are deducted. ANALYSIS/DISCOURSE As indicated, Bart asserted,”managers pad their budgets out of fear that senior management will arbitrarily slash their submitted budgets and the manager’s own concerns about uncertainties in the competitive environment.” Padding the budget is not the solution to be competitively advantaged in the business world. Padding the budget is the process of building budgetary slack into a budget by overestimating expenses and underestimating revenues. Details are available at Behavioral Impacts of Budget, . Why Pad the Budget? Employees and/or managers in charge of preparation of budgets resort to padding for the following reasons: 1. To give a buffer for contingencies. Managers often fear that any drastic changes in the environment would create changes in the funds that they already planned for specific purposes. By padding the budget, in case senior management would slash their proposed budgets, they think that there would still be enough funds left for them to continue with their plans. 2. To meet ‘padded” amounts easily thereby giving a perceived “objectives-easily-met” performance. If managers underestimated revenues, then, within a shorter period of time, they would meet their submitted goals. This would give senior management the picture that they have been efficient in achieving the target. In cases where managers overestimated budgets for costs, they feel that there will be enough leeway for price increases dictated by market factors. How to Avoid Padding the Budget. There are certain ways that management may consider to avoid padding: Upper management should educate budget-makers to the fact the budgets are not used to point fingers at someone when figures are not met. These should not be used as a tool for negative performance. 1. Employees should be given incentives, bonuses, or rewards for accurate budgets – not just meeting the budget. 2. Managers should be made strictly accountable for the budgets they make. By accountability, it means that these managers would be given the upper hand in making strategic decisions to correct any deviations that would result in changes in the business environment. 3. Senior management should review the budgets submitted to them before approving. This is a crucial phase because there might be times when complete trust is accorded to managers who prepare the budgets. By doing so, any slight padding of the budgets in aspects like salary increases, transportation allowances, representation allowances and the like might not be scrutinized. Details are available at Accounting 202 Home, Budgeting: Profit Planning and Control Systems Padding the budget will create chaos in the organization because certain decisions would be made from inaccurate plans. An underestimation of sales might cause serious repercussions in productions because only an understated volume would be manufactured. An overestimate of costs would cause waste and misuse of funds. These would definitely make the organization unprepared to face strategic decisions in the competitive environment. CONCLUSION The concepts in budgeting discussed above would guide practitioners in preparing, using and monitoring the budgets made. It should be emphasized that a budget is just a tool to assist management in their decision making process. At any point in time that there are drastic changes in the market factors, a budget should be revised immediately to correct significant deviations. Padding the budget is never acceptable and does not conform to theories and concepts in budgeting as well as in business ethics. Senior management in charge of reviewing and using the budget should be vigilant and perceptive in identifying the most accurate budget prior to approval. The concepts indicted herein would assist the managers in the preparation of an appropriate budget for their firms. The timing, elements, human resources and interplay of market factors should all be considered in the preparation of a budget. Of course, the mission and vision of the company should be taken into consideration. Any long term and short term plans of management should be included. The success of any budget is possible only with the assistance of all resources in the organization. A budget is just a tool, a guide, a plan. The decision maker is still on top of this financial plan. The manager should be able to make strategic decisions with the budget as a guide but with his business acumen to succeed in this competitive environment. REFERENCES Accounting 202 Home, Chapter 9:Outline Budgeting:Profit Planning and Control Systems, Budgeting:Profit Planning and Control Systems, Cost Definition, < www.investorwords.com> McCARTHY, E.J., 1975, Basic Marketing: A Managerial Approach, 5th edition, Illinois, Richard D. Irwin, Inc. MEIGS, W.B., JOHNSON, C.E., & MEIGS, R.F., 1977, ACCOUNTING: The Basis for Business Decisions, 4th edition, New York, McGraw Hill Book Company. VILLEGAS, L., “Basic Budgeting Concepts”, Finance-Entreprenuers, http://www.techba.com/wike/index.php Webster’s New World Dictionary,4th ed., 2000, Copyright Simon & Shuster, Inc. Read More