Important Areas to Consider in Preparing a Budget - Essay Example

Important areas to consider in preparing a budget Contents Contents 2 Abstract 3 Introduction 4 Management by objective 4 Traditional approach 5 Activity based budgeting 6 Technology and budgeting process 7 Conclusion 9 Abstract The report describes the process of budgeting in an organization, it details the traditional method of budgeting that many organizations have implemented; furthermore, the latest budgeting method such as activity based budgeting that is more practical can be used. It highlights why it is important to use activity based budgeting rather than a simple traditional budgeting format. Moreover, since it is a technology oriented era, hence for firms different budgeting softwares have been made available; but before buying any software for the process, some of the features and the qualities of the softwares so described need to be taken into consideration. Introduction Budgeting is basically a periodic or more often round the year activity, that helps the organization’s management in formulating clear expectations regarding what management wants the organization to be in the future i.e. the length of the planning period. Budgets in organizations can be made only at the top level or the top management may take a more participative approach in preparing the budgets for the company. The participative approach requires taking in inputs from all levels of employees and then formulating one single budget. Management by objective The organizations adopting the management by objective approach usually follow a participative approach. In management by objective kind of approach towards making the budgets the top management of the organization has pre set goals for the overall organizational objectives, these are derived from the vision and the mission of the organization (Castellano & Lightle 2005); these objectives are then flowed down to the middle management level, at this level the pre determined goals are then kept as the targets, rewards and incentives are given in circumstances the goals are met smoothly; the lower levels which are supervised by this level are then monitored to check for any variances that might occur between the budgeted and the actual. The bottom up approach helps managers set their own goals that contribute towards the attainment of the organizational goals; this requires managers to put in more effort compared to when the top management sets the objectives only. It is important in budgeting that all the management levels provide input because, input from the lower levels will make them work or contribute more dedicatively to the the attainment of the goals. Traditional approach Most of the organizations use the traditional budgeting approach, but this approach now present a very narrow sighted view of the managers. Since this requires preparing a budget and leave to out just to check at the end of the year whether the performance has matched the budgeted or not and no actions are taken in between to correct any deviations that might occur for the worse. Furthermore, drawback of using the traditional budgeting method is that in the traditional method the responsibility of budgeting is divided amongst the concerned managers only and since the traditional method is based on the system of general ledger, hence the managers budgeting, forecast only the direct materials, revenues, expenses etc. that fall in their own domain of responsibility; hence the profitability of the company overall is not forecasted since it is not the responsibility of any other. When the budgeting process is being performed it is important that the measures used in the budgeting must be linked to the operations of the company that results in the profits to be generated. Moreover, managers should really know where the expenses are incurred, in actual it is the positioning of these resources (Nolan) that matters the most. The space occupied has its cost in the shape of either the rent or else the opportunity cost of itself, the remuneration, salaries or the benefits that have to be paid to the employees that work; the cost of the full time and the part time or the contractual workers also add to the cost. Machinery expense, its maintenance and the operational expense when it operates, the wear and tear of the machinery and more importantly the utility expense also counts as the major operating expense that need not be ignored. Since there is a difference between how much cost is incurred by what department, thus when budgeting the manager should initially identify where the actual cost occurs, allocation of total cost to a single cost centre or allocating disproportionate amount of cost here and there is a very wrong approach. Activity based budgeting Thus, considering the factors in mind, accountants have come up with ABB or what is known as the activity based budgeting; this considers cost from the cost management system most popularly known as the activity based costing so that over allocation or under allocation of costs does not occur (Nolan). But, activity based costing that transfers costs of the back office to the front office is not what is required today. But, the true nature of activity based costing is based on the cost drivers, that is those activities that in really drive up or down the cost of the total system. This method allocates cost on the basis of how actually the capacity is utilized, or where in actual is the cost incurred to add value. The process of activity based budgeting links the costs to the real activities performed (Snyder), that is the actual profitability linked to the profit centre. The basic management of the business requires the financial performance information that is the profit centre profitability, product profitability, customer centre profitability and the resource utilization reporting. By, knowing all these managers can reach down to the linking of the activity with the real measures. Thus, profitability of the business can then really be measured and budgeted properly. Now, after knowing what the actual costs are managers need to reach down to the profitability that is the ultimate outcome required of all the planning efforts put in. To budget profitability it is important to know the transaction volumes, these are compared to the actual volumes that occur. The budgeting transaction volumes present an integrated view of linking the back office with the front office (Snyder). The debits and the credits in the journal are known, and normally the planned debits normally occur at the front level and can be linked to the back office credit entries to forecast the level of the resources that will be needed to process the work in the back office, that supports the front. Technology and budgeting process Today, with the advent of information technology infrastructure, in all the areas of business management, and the needs of real time sharing of information growing across the globe as businesses grow and become global, no business can survive without it. Therefore, the software that a business might consider using to support the budgeting process need to have certain features that support the long term goals of the business. The software should have qualities like scalability, it should have architecture and a platform, the software should be specific and meet the needs of the industry well; the cost, interfaces, training required to facilitate employees should be adequate etc. (Snyder). It is all important to consider this, since the company’s budgeting methods and tools can be more customized to a particular software or the whole architecture that the firm is willing to purchase. When it is said that the organization should have a budgeting software that is scalable, it really means that the software is scalable in the sense that its user base can be quickly expanded as the number of users increase; since we talked about budgeting being more beneficial and accurate and practical if inputs from the responsible managers are taken personally, therefore, scalability to support the expanded user base is necessary. More important is that since the information sharing needs of the organizations are growing and the need to maintain large and larger databases is the talk of the town, thus, scalability should also mean that information holding capacity can be quickly enhanced. For budgeting, information should be accessible on time; The software should be such that no additional softwares and reporting solutions are required. Software architecture should be supported by one vendor only because there might be occurrences of security, hierarchy, definition and the other reporting issues throughout the organization. The platform used for the process should be well known and developed such that if any activities need to migrated then transfer from here and there is not difficult. A common solution that is linked to all other organizational systems will be easy for people to use and hence cheaper for the firms themselves. The software should not rely on the data solely, instead, database independency lets leveraging from the database solution that the organization may be already benefitting from. All industries are unique and it also becomes difficult to define the boundaries of an industry, because of the substitutes that might exist. For, budgeting the software that the organization may require the software should be tailored because many factors that are used to analyze a particular industry differ from those that are used to analyze others. Some industries’ performance can be evaluated through the liquidity ratios and other through their profitability ratios, for companies that are a part of industry with huge tangible assets, financial position of the company is important and those that rely of cash generation through revenue and other performances, income statements better serve the purpose. Hence, the software more customized to specific industry needs is important. It is known that organizations are better of using softwares, that support all kinds of approaches to budgeting that is the top-down, bottom-up etc. Since organizations are evolving and are moving from entrepreneurial organizations to more networked organizations, hence transformation in their systems is also occurring. Thus, empowerment, decentralization and other buzz of the town approaches can easily be supported by such a methodological support of the software and the system. The cost of the software varies from each organization to the other; however, implementation of a particular software in any industry depends on the affordability of the organization. Managers responsible should have know how and should spend enough time up front to determine the actual cost to purchase, install, develop, and maintain the solution; the implicit and all the explicit costs should be taken into consideration. Implementation of the software is not enough employees should be able to use it and that too constructively for the organization. Training expenses become a part of the cost for the organization and must be considered. Training might be costly for the organization, but must not be considered a burden, since it pays off in the longer run and has no immediate returns. The interface of the software should be as user friendly as possible and the solutions that generally meet all the functional criteria should be embedded and employees should be provided with great tools for interfacing with the defined applications that are used for the systems and procedures in the organization. Conclusion To conclude, when budgeting all the concerns, the critical factors should be taken into account and thus firm can more precisely be able to predict the future, and the variances between the budgeted and the actual can be minimized. Research has proved that biggest failure in budgeting process arises from managers’ avoidance of getting down to each and every intricate detail. But the use of information technology infrastructure and by automating the systems and the procedures, the management can develop and regularly update the budgets. The trend nowadays is towards the preparation of the rolling budgets and the forecasts, where management can update the budgets for example a year ahead as the quarter passes by. An advantage of such an approach is that continuous rolling and updating can help managers be more near to the environment that is dynamic and effect the outcomes. Factors such as inflation, fluctuating exchange rates, political instability, changing interest rates etc. can be applied that are more recent and best suited to that particular time period. References Castellano, J.F., & Lightle, S. S. (2005). Using cultural audits to assess tone at the top. CPA Journal Nolan, G. J. The End of Traditional Budgeting. Journal of Performance Management Snyder, K. Budgeting and Forecasting; Behind the Screens! The Journal of Bank Cost and Management Accounting Read More