The Capital Budgeting Decisions - Essay Example

?Budgeting Introduction Budgeting is one of the most important managerial tools, which helps the managers choose among different projects based oncash flows and rates of return. Tatum (2011) states, “Capital budgeting is a fiscally responsible process that is designed to manage available resources to select the long term projects”. The managers choose those projects for investment, which are likely to generate considerable profits for their companies. Budgeting makes the processes of the organizations run efficiently. Morgan (2006) states, “The success of a business depends on the capital budgeting decisions taken by the management”. So, it is of crucial importance for any business or organization to develop a perfect budget plan which should not only help the organization in achieving desired goals but also in maintaining the financial level of the organization. In this paper, we will discuss budgeting with respect to the construction industry. We will describe the functions of budgeting along with the role of budgeting in motivating behaviors within organizations. We will also discuss how potential dysfunctional consequences arise from the actions that budget holders may take when they are responsible for the budget. In the end, we will describe some ways which organizations can use to ensure whether budget holders are motivated to achieve organizational objectives or not. 2. Functions of Budgeting 2.1 Financial Analysis In construction industry, budget helps companies in the process of financial analysis. Through budgeting, management of the organizations can know the financial position of the organization. They can know what is actually going on in terms of capital use for business activities. Budgeting helps in providing the management with the information regarding available capital, current financial position, and future expenditures of the ongoing business activities. Through efficient budgeting, the organizations can save money and related expenditures regarding various business activities. Budgets help in cutting off the extra costs and make money available for use in other financial activities. 2.2 Planning Proper planning plays an important role in the success of a construction company. Budgeting plays a very important role in this regard. Planning is the second function of budgeting. After forecasting the financial position, a company decides its future activities, such as, investment decisions, loan decisions, and buying or selling decisions. 2.3 Communication Communication is another major function of budgeting. If an organization makes some sort of financial deal with another organization, budgeting is that technique which can resolve the issue related to use of capital between the two parties. Priorities can be set between the two organizations regarding the financial issues. An effective budget would help the organizations in communicating with each other for the purpose of discussing where the money should be spent and how much money should be spent. 2.4 Motivation Budgeting plays an important role in motivating staff of the company. After analyzing the financial position of the company, managers can develop such plans for the employees that are able to improve their efficiency and motivation. For example, if a company develops effective compensation plans, it can result in favor of the company because employees like to work for a company which values their performances and provides them with the compensation and rewards that they deserve. However, development of compensation plans is directly related on the available budget of a company. If a company will have enough budgets for developing and implementing such plans, only then compensation plans can be developed which will ultimately result in motivating employees and improving their individual and group performances. 2.5 Evaluation In construction industry, evaluation of financial and other business processes plays a very important role. Budget represents the target performance which managers measure with the actual performance of the company. Evaluation helps in continuous comparison of budgeted results with actual results of the financial activities performed by any organization. If the implemented policies produce positive results regarding any specific financial activity, management of the organization keeps those policies with the budget plan but changes those policies if results come other than expected. 2.6 Control Budget is that key which enables an organization taking charge of the finances. With the help of an effective budget, the management of any organization can decide when and what to do with the capital. It is a fact that no construction company can ever be successful without having an effective and efficient budget control regarding financial affairs. Budgetary control is of extreme importance for the survival and success of any organization in a competitive market. Without a proper budgetary control system in operation, no financial activity can be performed successfully; rather it can result in financial crises for the organization. It is because when there will be no check and balance in case of monetary affairs, capital required for the completion of any goal or business activity will get misused. 3. How Budgeting can Motivate Employees Budgeting can play a very important role in motivating employees of the company. As described above, compensation and benefits plans and salary raise based on the analysis of financial condition of the company play a very influencing role in this regard. Compensations are those rewards or remuneration, which a company offers to its employees as a result for achieving some desired sets of goals and objectives. Compensation and benefits play an essential role in motivating employees of the company. The employees like to work for those companies, which consider employees’ needs and concerns while designing budgets. Employees show more concentration and interest towards their work when they know that the company will appreciate their hard work in form of rewards and cash prizes. Rewards help the companies achieve higher employee productivity. To increase motivation of employee, a company can reward its employees through many ways. One of the common rewards is basic salary plus bonus that includes fixed bonus amounts for employees who show excellent performances. Moreover, increase in the salaries of employees can also motivate behaviors within organization. Implementation of a compensation plan and salary raise not only motivates employees but also benefits the company’s business. It is because when the employees of the company will show progress in the work, the company’s productivity will increase as a result which will make a good impact on the company’s overall ratings. The design of the compensation plan depends on the financial conditions of the company. If a company is not financially stable, it will not be able to provide rewards and bonuses to the employees. Understanding the financial condition of the company is extremely important in order to design a realistic compensation plan for the employees. Those companies are very successful, which provide realistic bonuses, rewards, and salary raise to the employees. Therefore, a company never develops such compensation plan, in which prizes and bonuses go beyond the available budget of the company. 4. Potential Dysfunctional Consequences Arising From the Actions of Budget Holders Some potential dysfunctional consequences can arise from the actions that budget holders may take when responsible for a budget. Preparing and holding the terms of the budgets is the responsibility of humans. Therefore, a little negligence can create problems both for the company and the budget holders. In case of construction companies, budgets hold great importance because every business activity totally depends on the available budget. Reames (2010) states, “It's always important to figure out areas of your budget where you tend to spend exorbitant amounts or unnecessarily and cut those out”. If people associated with the task of handling the budget show some kind of negligence, it can cause adverse effects for the overall business of companies. For example, if a construction company takes a project of building 50 houses in a new land developed by some firm, the company needs to have required budget in account n order to complete the project. If people, who are responsible for using the company’s budget, do some mistakes in forecasting and calculations, it can put an adverse impact on the project because unavailability of money at any point of time is like stoppage of blood for the life of the project. Similarly, if people concerned with the development of budget make some kind of mistake in the analysis of company’s financial position, it can result in affecting forecasting function of the company. The job of managers is to take proper decisions based on the analysis done by the budget makers. If budget makers do not provide managers with correct analysis, managers will not be able to take correct decision regarding future investments, development of compensation plans, and other business processes. Therefore, we can say that budget holders need to look at every aspect of the financial condition of the company, predicted income and expenses, and actual monthly income and expenses while making budget for the company. Biglefeld and Zoumbaris (2000: 85) state, “It does take careful thought and planning to budget your money”. It is the responsibility of every budget holder to take care of his/her area of responsibility regarding budget. Budget holders control all financial activities of their respective departments in order to avoid any financial mishap. If a budget holder miscalculates something related to administration of budget, it can affect all activities of the department because money is needed to run every activity. 5. Ways through Which Organizations Can Ensure Motivation of Budget Holders There are certain ways through which organizations can ensure motivation of budget holders towards achievement of goals and objectives of the construction companies. Budget holders are usually heads of the departments who manage all money allocated to them by the top management. In construction companies, the process of annual budget allocation holds great importance because every department works on large scale ensuring higher levels of productivity for the company. Providing large amounts of money to the departments is not considered a viable option to ensure motivation of budget holders. Rather appropriate budget portions should allocated to each department using which concerned employees can run business activities properly. When budget holders will have no concern regarding allocation of budget, they will work with full concentration towards fulfillment of the goals and objectives of the company. Allocated budgets should neither be too high nor should it be too low that employees become unable to perform their activities. A good portion of budget can motivate employees work efficiently towards the fulfillment of goals and objectives. One point that needs to be considered is that budget holders want to take part in the budget-making process. They do not want the budget to be imposed on them by the top management. One way to increase motivation of budget holders is to involve them in taking decisions regarding development and allocation of budgets. This approach is known as consultative approach towards budget-making process. Doing this, the top management can get success in motivating and inspiring the budget holders towards achievement of organizational goals and objectives in an appropriate manner. One more way which top management can use to motivate budget holders is to introduce some rewards for achievement of organizational goals. For example, if a department shows good performance, the top management should reward all employees of the department with some rewards and bonuses. Using this way, the top management can motivate all budget holders to work more effectively and efficiently towards the achievement of organizational goals ad objectives. These were some of the ways through which top management of the construction companies can ensure motivation and inspiration of the budget holders towards achievement of the goals and objectives. 6. Conclusion Summing it up, a budget is a financial plan expressed in terms of money that helps budget holders achieve organizational goals and objectives in an appropriate manner. Budgeting pays an important role in motivating behaviors within organizations. Budget holders need to show extreme care towards use of the allocated budget because potential dysfunctional consequences arising from the wrong decisions of the budget holders can affect overall business. Organizations need to take correct decisions regarding allocation of budget to different departments of a company in order to motivate budget holders towards the achievement of desired goals and objectives. References Bijlefeld, M & Zoumbaris, S 2000, Teen Guide to Personal Financial Management, Greenwood Publishing Group, Westport, CT. Morgan, E 2006, Capital Budgeting, viewed 18 November 2011, . Reames, P 2010, How to Develop a Budget and Stick to It, viewed 18 November 2011, . Tatum, M 2011, What is Capital Budgeting?, viewed 18 November 2011, . Read More