The Management of a Companys Finances - Essay Example

Budgeting The management of a company’s finances is an important element to any corporation as it hinges on the potentialof success and failure of a business. The best way of ensuring that this management is done appropriately is through the process of budgeting (Obstfeld, 2008). Budgeting can be described as the careful planning of an organization’s funds based on the various costs and expenditures that a business faces and the means in which these funds will be distributed amongst them (Lasher, 2010). A simpler and straight forward explanation would be that budgeting is simply the development of a budget. A budget can be defined as an economic plan for a certain period of time according to available funds (Obstfeld, 2008). A company cannot function without budgeting, and it is essential that the methods and techniques used during this process are appropriate to the business in particular in terms of the approach and objectives that feature in that particular organization (Bartle & Shields, 2008). Good budgeting results in financial success for that particular accounting period and will reduce the risk of a company mismanaging the funds that are available to them which in serious situations could lead to disastrous results if not kept in check such as bankruptcy among others (Lasher, 2010). Once a proper budgeting plan has been established, however, these risks have a higher chance of being avoided and put the company in a better position to maintain their position in terms of economic stability. Purposes of Budgeting There are a number of purposes of budgeting that can be identifies as the main reasons for the activity, some of these include: Financial Forecasting – Budgeting provides an overview of the expected financial position of a firm at the end of an accounting period if the various strategies implemented succeed in achieving the objectives set out for them at the beginning of the period (Diamond, 2008). Budgeting allows the organization to predict the economic situation they will find themselves in at the end of a certain period if everything goes according to plan in terms of revenue and expenditure. Establishment of constraints – Budgeting also ensures that a company does not mismanage the funds at their disposal in a manner that may lead to irrecoverable financial difficulties through the placement of constraints on the maximum amount of money they can spend on a particular activity or area (Lasher, 2010). The establishment of these constraints ensures that the company remains within the economic safety net that is created by the budget and avoids any financial risks that would have otherwise potentially occurred. Comparison – Budgeting allows the actual finances of the business to be compared with the predictions that have been set out in the forecast in a bid to determine whether they are actually achievable or should they be adjusted if necessary (Lasher, 2010). This method of comparison allows the company to take a look at the economic success that the business achieves and the potential success it will be able to attain in the future (Blaug, 2007). This ensures that the company can plan appropriately according to these comparisons in relation to the financial position of the company. These can be considered to be the main purposes behind budgeting and represent the importance of this activity to a successful business. Budgeting Process There are a number of stages that exist within a conventional budgeting process that can be implemented on a global scale by various companies (Lasher, 2010). These steps follow a protocol that allows the organization to properly develop a means of appropriately allocating the available funds to the various different parts of the business according to the particular needs of these sectors as well as the objectives that have been set out (Diamond, 2008). These stages are as follows; • Firstly the main objectives of the business are identified in relation to activities that will require funding so as to accomplish them. These objectives may vary from department to department and should be arranged according to essentiality (that is, with the most important taking priority over the others). • Secondly identification of potential strategies that will allow the business to successfully achieve the objectives that have been identified (Blaug, 2007). There should be more than one strategy that is suggested to allow for the option of choice which increase the chances the most appropriate being chosen. • Once these strategies have been identified, they are then evaluated closely to determine the pros and cons of implementing them with regard to attaining the goals of the company (Lasher, 2010). The strategies are carefully scrutinized to determine which would be the best to be used by the company (Bartle & Shields, 2008). Once the various strategies have been evaluated, the best out of all the available options should be chosen. • Once the desired strategy has been chosen, the next step consists of implementing it (Mittra, Anandi & Crane, 2007). The implementation stage should be done with care, and it should be made sure that it is done precisely according to how it has been designed to enhance chances of success. • The next stage after implementation occurs after a period of time once the strategy has been set in place and involves the evaluation of the results that have developed as a result (Diamond, 2008). These results are compared to the results that were expected to determine the success of the strategy. • The last stage involves the implementation of corrective measures where necessary to improve on the design of the strategy and increase its level of success as well (Lasher, 2010). These measures are taken into account according to the various mistakes and weaknesses that have been identified from the evaluation stage and are done in a bid to enhance the effectiveness of the strategy (Blaug, 2007). In circumstances where the strategy may have completely failed, a whole new strategy may replace it. If these steps are followed in the development of a budget and the financial administration that occurs afterwards then it there is a higher chance of the business succeeding, and the company achieving the various objectives that it has set for itself at the beginning of the accounting period (Robinson, 2007). This process also avoids any form of confusion that may have otherwise arisen in regard to the expenditure of the various funds that have been made available. Types of Budgeting There are a number of budgeting techniques that a company is able to choose from according to their particular needs and desires (Bartle & Shields, 2008). However, these types all hold the same main function, and that is the proper management of company funds that will achieve the objectives that have been set out by the company for the business. Some of the popular budgeting types include: Zero-based Budgeting This is an advance to the traditional form of budgeting that can be said to reverse the process that takes place in the development of a budget (Berezin, 2005). Whereas in traditional approaches to budgeting an individual only justifies the variances in relation to those from past years zero based budgeting involves the approval of every line item within the budget (Diamond, 2008). This is because during the review of the budget, there is no mention of the previous expenditures that have taken place before that point. This type of budgeting requires that the budget be evaluated again starting from the zero base with no reference to past activities and numbers. Activity Based Budgeting This type of budgeting involves the provision of funds for a particular activity based on the levels of funding that is required in relation to the expected results that are to occur. This type of budgeting focuses on the relationship between the levels of expenditure and the expected outcome that results from these investments and are a good way of determining whether the level of funds required are worth the results that have been predicted to be the outcome (Lasher, 2010). This type of budgeting is implemented by those managers that wish to have a more cost efficient approach as well as effectiveness in relation to the funds spent and can be used when a company is trying to cut back on their expenditure. This has become one of the more popular approaches due to the recession that is being experienced globally at the moment. Both these approaches can be implemented in the development of a budget, but one has to consider their various limitations as well (Bartle & Shields, 2008). For example with regard to zero-based budgeting one disadvantage is that it takes more time to develop in comparison to incremental budgeting (Berezin, 2005). Activity based budgeting on the other hand also has its disadvantages such as the fact that this type of approach sets strict limitations on the amount of funds made available which may make it hard for a manager to function and perform their duties efficiently as they are forced to work within a budget that has little wiggle room (Berezin, 2005). One of the main models that can be used by a number of companies is beyond budgeting which involves looking beyond the main factors such as control of the funds and delves a more adaptive approach to the process of budgeting (Diamond, 2008). This flexibility allows the manger to deal with circumstances according to their particular features which will increase their chances of success. The model encourages innovation in the development of budgets and attempts to release the pressures that tend to place on mangers from established bureaucracies (Lasher, 2010). The type of budgeting will affect behavioral aspects of the mangers involved as they will have to adapt their actions to fit the type of budgeting being implemented (Berezin, 2005). For example, one using the beyond budgeting model will be more free in his actions as compared to one involved in zero-based budgeting. References Arthur M. Diamond, Jr. 2008. Science, economics of", The New Palgrave Dictionary of Economics, (2nd Ed.), Palgrave Macmillan, Basingstoke and New York. Bartle, John R. and Patricia M. Shields. 2008. Applying Pragmatism to Public Budgeting and Financial Management. Faculty Publications-Political Science. Texas State University. Berezin, M. (2005). Emotions and the Economy in Smelser, N.J. and R. Swedberg (eds.) The Handbook of Economic Sociology, Second Edition. Princeton University Press, Princeton, NJ. Blaug, Mark. 2007. The Social Sciences: Economics, The New Encyclopædia Britannica (27). Lasher, W. 2010. Practical Financial Management. South-Western College, Boston, Massachusetts. Obstfeld, Maurice. 2008. International finance, The New Palgrave Dictionary of Economics, 2nd Edition, New York. Robinson, M. (ed.), 2007. Performance Budgeting, Linking Funding and Results. Palgrave Macmillan, New York. Sid Mittra, Anandi P. Sahu, & Robert A Crane. 2007. Practicing Financial Planning for Professionals (10th Ed.), Rochester Hills Publishing Inc, Michigan. Read More