Effectiveness of Budgetary Control - Coursework Example

Budgetary Control and Effectiveness of Budgetary Control A budget is a plan of action prepared in a quantitative form by the management to provide operational guidance for the future time period (Dutta, 2003). Budgeting, therefore, is the process of coming up with a budget. Budgets are critical to all organisations as they are often the main decision making tools. Forster and Wanna (1990) observe that budgets have been used for centuries to plan and execute business strategies. A business strategy refers to the process of identifying the organization’s capabilities and effectively matching them with the organisation’s opportunities. Budgeting, if done in the right way, therefore, can play a huge part towards the organisation’s profitability. Budgeting is thus an iterative process where the plans, budgets and strategies affect one another (Hirsch, 2000). In a traditional business setting the past data from the financial department is used to forecast the organisation’s performance in a financial period. The forecasting, therefore, is usually based on the presumption that the business environment is not going to undergo any radical changes (Kotter, 1996). But that is a faulty presumption. The current business environment is radically changing. It is very dynamic and unpredictable rendering planning based budgetary systems inappropriate (Neely, Scutcliffe and Heyns, 2001). These budgetary systems are the most popular so many business are not willing to have paradigm shifts in the way they budget. The only relevant solution asserts Lucey (2003), is to use planning based budgetary systems but have effective budgetary control measures to regulate the budget implementation thereby making sure that the intended objectives are met at last. If no budgetary control measures are instituted there is a high chance that the budgeting decisions will end up misleading the firm because the assumptions that were used to make the forecast are not holding up anymore (Debarshi, 2011). Planning Based Budgetary Process Planning based budgeting is a budgetary system where the budget is an aggregate of the various performance plans by the various cost centres of the business. Each business department comes up with their objectives and plans for achieving those objectives. The plans are translated into quantitative monetary forms and aggregated together to form the master budget. Plan based budgeting is slow and unresponsive especially at this point in time where the business environment is rapidly changing and the trends unpredictable (Emmanuel, Otley and Merchant, 1990). The formal budgeting process is long and by the time the final budget is prepared already some factors have changed. For example, ordinarily the process starts with the forecasting of the economic conditions which then inform the preparation of a sales budget in anticipation of favourable economic conditions. After sales budget, the production budget is prepared, then the capital expenditure, the cash budget and finally the master budget. It is evidently a long and slow process which results to incorrect forecasting because of the changing environment. A management that is reliant on this data is bound to make an error in forecasting. This may result to the business incurring losses instead of the desired profitability. The only way to take care of these deviations is by instituting effective budgetary control measures (Hitt, Ireland and Hoskisson, 2008). Effective budgetary controls and potential solutions Most budgets prepared are static but there are many businesses that use the flexible budgets. The budgetary control measures are supposed to evaluate the budgetary process that was used to come up with the budget. The budgetary control measures will detect any counterproductive elements (McKinsey, 2011). The areas that are not operating as anticipated are highlighted and potential corrective measures evaluated to correct the deviation. Budgetary controls are, therefore, meant to align the areas with the initial goals regardless of the change in economic environment and circumstances. The budget is a quantitative plan. It quantifies those business aspects that are crucial and are quantifiable in monetary forms. An effective budget control measure should also be able to quantify the non-financial business aspects. The use of traditional direct supervision cannot detect unfavourable variance in non-financial business aspect (Hartog, 2013). For instance, a change in employee morale cannot be detected by direct supervision but can be detrimental to the organisation’s performance if not addressed on time. The change of employee’s attitudes is an internal factor which may be through direct supervision and observation can be detected. However, external factors may be hard to detect yet they, too, affect the business’ fortunes especially where the business environment can rapidly change. A change in customer’s tastes and preferences, for instance, is crucial. The budgetary control in the middle of the trading period will detect the changes and variances in the sales budget and will find a means to salvage the trading period (Kumar, 2010). Budgetary controls also can provide in depth insight into the health of the organisation. According to Magical (2011), budgets are decision making tools that often rely on historical data to make decisions. This information sometimes is inadequate for a correct viable decision to be arrived at. Through a budgetary control intervention the prevailing market conditions can be ascertained and used to make the correct decision (Hofstede, 2012). It is akin to making decisions in real time versus making decisions based on reports generated over months or years ago. Certainly, the decisions made in the real time will be more insightful since the prevailing conditions have been taken into consideration. Budgetary control techniques that can be applied here, for example, include the use of automated management information systems (MIS). This system should be able to collect, collate, and synthesize financial data. Adequate information can be obtained which aids in correct decision making. Budgetary control measures not only pit the budgeted versus the actual performance at a specific time in the budgetary period, it also offers insights into the possible reasons behind the deviations (Wallis, 2009). Budgetary control measures will evaluate how the organisation is performing against how it was supposed to perform. The variances will be detected and measures taken to address them. Such control measures focus on the overall business objectives and the objectives of the particular cost centres. All commercial businesses are operating with the aim of making a profit. The overall objective of such a business is to reduce the cost as much as possible and to maximize on its profits through market efficiency. Management by objective is a control measure that can be used to detect and explain variance. The overall business objective is the aggregate of the cost centres mini-objectives (Hitt, Ireland and Hoskisson, 2008). The managers in these cost centres will be tasked with noting the variance and providing the ways to address them. For example, if the production manager notes that there is a reduction in the raw material supply because their prices in the market has increased more than the budget had envisaged, the manager can factor that in the budgetary review. Using the management by objective control technique, a budgetary control can be performed even on a monthly basis (Kotter, 1996). It is easier to deal with a dynamic and unpredictable market when the review is done in quick succession. The changes can be taken into consideration when decisions are being made. One of the biggest problems with the planning based budgetary systems is that they do not factor in intra-budgetary period reviews. The organisation uses the budget from the start to finish without updating it to reflect the changing business environment. An effective budgetary control measure would ensure that the changing circumstances are taken into consideration through periodic revision and updates (McKinsey, 2011). As noted earlier, the overall business objectives are usually the aggregate objectives of the various cost centres. The problem arises when the top management tries to impose its own objectives on the employees. The frontline employees are the ones who really know how the company is performing (Kotter, 1996). They are the ones who know the amount of popularity or goodwill that the business organisation is enjoying at the ground. The frontline employees and managers should be involved in the budgeting decision of the firm. Most planning oriented budgets pretend to have generated from the lowest of ranks in the organisation but the reality is that the top management ultimately decides the amount to be allocated to each cost centre. The strategic managers typically rely on historical data to make the budgetary decisions. If the business environment experiences a radical change then the budget analysis will record unfavourable variances in almost all cost sectors. Dutta (2003) proposes that to avoid this mishap the middle and the low level managers should be involved in the initial drawing and the review of the budgets during the budgetary period. These managers will, for example, be better placed to conduct a break even analysis and prepare the financial statements. Lastly, an effective budget control measure should be done continuously to envisage the changing circumstances. Since the formal budget processes are slow it may be hard to prepare a budget that is reflective of the prevailing circumstances. However, if the budgetary controls are conducted, preferably in a quarterly basis, then the changing business environment can always be taken into account when the budget is reviewed (Hirsch, 2000). Conclusion The business environment is increasingly becoming unpredictable and dynamic. The formal business processes are, however, very slow making the business to potentially develop an obsolete budget when the environment rapidly changes. Such budgets need constant updating which can be duly provided through budget control measures and techniques. The control measures, if effectively implemented, will ensure that the organisation has a relevant and up-to-date budget to operate with (Lucey, 2003). References Debarshi, B., 2011. Management accounting. New Delhi: Pearson Education India. Dutta, A., 2003. Cost accounting: Principles and practice. New Delhi: Pearson Education India. Emmanuel, C. R., Otley, D. T., and Merchant, K., 1990. Accounting for Management Control, 2nd ed. London: Chapman and Hall. Forster, J., and Wanna, J., 1990. Budgetary management and control: The public sector in Australasia. Sydney: MacMillan Education AU. Hartog, G., 2013. Effective budget control techniques. King Cash Cow, [online] Available at: [Accessed on 25th February 2014] Hirsch, M., 2000. Advanced management accounting. London: Cengage Learning EMEA. Hitt, M., Ireland, D., and Hoskisson, R., 2008. Strategic management: Competitiveness and globalization, concepts. New York: Cengage Learning. Hofstede, G., 2012. The game of budget control. London: Routledge. Kotter, J., 1996. Leading change. Harvard: Harvard Business Press. Kumar, V., 2010. Importance of budgetary control. Svtuition, [online] Available at: http://www.svtuition.org/2010/06/importance-of-budgetary-control.html [Accessed on 25th February 2014] Lucey, T., 2003. Management accounting. London: Cengage Learning EMEA Magical, M., 2011. Effective budgetary control processes for corporations. Inside Business, [online] Available at: [Accessed on 25th February 2014] McKinsey, J., 2011. Budgetary control. London: BiblioBazaar. Neely, A., Stucliffe, M. R., and Heyns, H. R., 2001. Driving Value Through Strategic Planning and Budgeting. London: Accenture. Wallis, L., 2009. Budgetary control. Nursing Standard, 23(25), p.64 Read More