Budget in Management Control Systems - Report Example

Budget in Management Control Systems Introduction: The purpose of this paper is to critically evaluate the use of budgets in management control systems. For this matter, it is essentially important to understand the exact implications of what a budget effectively is, what it entails and what allusions it would have on the company which employs it for its financial management. Based on these arguments, this paper would the go on to ascertain the subsequent effects of budgeting on management control systems and what advantages and disadvantages they bring to the organization which has implemented this system. The paper would be concluded by ascertaining whether the given statement at hand has been vindicated by the conducted study or whether it still remains unproven. (Abernethy et al, 1999) A budget: The first and most critical step of this paper is to understand what a budget actually is and what it entails for an organization. The budget is written documented statement of the future plans of a company set forth by the management which are demarcated in monetary terms is known as a budget statement. This report is basically indicative of the future performance of the company in accordance with the perceptions of the managers. The process of budgeting in the eyes of many is basically the lawful marriage of the accounting and the managerial entities that exist inside a business. However, according to most of the renowned personalities in this field, the process of budgeting is more the prerogative of the managerial function of the business rather than the financial function which is backed by the rationale that the formulation of this plan is in an attempt to better aid and abet the managers of the firm in the proper and utility maximizing mechanism of management of the firm. (Churchill, 1991) Systems for decision making, determining the objectives for the company and earmarking the main concerns of the organization all come under the jurisdiction of the formulated budget. Now, the budget is not merely a managerial instrument but rather has accounting implications as well as the future goals of the company are interpreted into financial goals which have to be met. Therefore, it would not be wrong in considering that a budget is perhaps the most effectual mode of business management that is present in the contemporary business landscape. (Demski, 1994) Advantages of Budget Preparations: The level of revenue that will be appropriated for the business activities of the business will be determined by the budget and this allocated amount will determine the level of outlays that the business can ascertain and the final closing balance present to the operators of the business at the end of the period of activity for which the budget was ascertained. A financial management tool as we have already described, the possible applications of a budget include: Determining particular goals for the future Assessing the activities conducted in the past in light of the activities planned for the future, Lay down the formulation of work plans, Predict the levels of revenue that will be made available to the organization, Forecast the possible avenues of outlays of these funds, Compare and contrast the actual results that are found with the planned results as determined by the budget, Pinpoint the areas of business that have the potential of being problematic and need special consideration, Approximate the final level of revenues at the end of the period encompassed by the created budget, and Act as a public information dissemination system. (Gitman et al , 1977) (Harris et al, 1996) (Harris et al, 1998) Methods for Budgeting: According to most financial analysts and business groups around the world, there are three major ways in which a budget can be compiled: Incremental budgeting This method is budgeting is the one where the budget for the current financial term serves as the basic building block for the new budget that has to be formulated for the next year. Budget adjustments cater to the possibility of differences in actions planned for the next year and those in the current year. Expected changes in revenues and outlays also oversee budget adjustments. The major benefits of this method include less use of time in budget creation and better budgeting for items of basic cost. Disadvantages include the un-identification of existing budget errors. (Hasan et al, 1997) Zero budgeting Starting from scratch and building a budget from this starting point is the basic idea behind the zero-based budgeting method. This method allows every business to undertake a fresh perspective at every level of production without having any predisposed notions or being affected by prior levels of production. Its advantages include a better tool to compare the program performance of the budget at hand with the performance of the company in the previous financial term and a considerably better resource for future projections of revenue streams. A lot of time is required to create a budget using this method and despite the best efforts of the organization, some costs again get budgeted based on historical data rather than from zero, which is the purpose of this budget e.g. examining existing data for historical use combined with the projected rate of inflation gives the best estimate for the cost of general supplies. (Modigliani et at, 1958) (Pindyck, 1998) Combination of incremental and zero-based Many budgeting specialists consider the best process for budgeting to be an amalgamation of the zero-based budgeting method and the incremental budgeting method. The need of an item decides the budget value of these said items devoid of any predetermined impressions of the budget based on the statistics ascertained from the previous year. For other items, only price change adjustments are needed for the budget. Therefore, every item of the budget will itself determine what method of budgeting should be applied on it. Let us assume an example where a production firm expects a huge augmentation in its consumer base over the next period due to the greater desirability of its product, then I is better to budget revenue and expense streams from zero base. On the other hand, in the instance of similar levels of demand, revenues and cost the incremental budgeting may be enough. (Ross et al, 1999) (Hilton et al, 1994) Significance to an Organization: This paper has aptly described the theoretical section of the argument at hand thus far i.e. what exactly a budget entails, the advantages of formulating a budget and the mechanisms of creating a budget. However, as it has been perceived across the contemporary global business environment, theory rarely counts for much if it is not aided, if not backed by practical application. Therefore, it is essential that this paper tries to ascertain the practical benefits of budgeting. First of all, the most important benefit that budgeting provides to an organization is a sort of an action plan for the activities that they would want to pursue over the course of their next financial term. It can be argues that plans that are made much in advance do not necessarily lead to fruition which could become a major argument against the budgeting process, but it is critical to understand that budgeting only provides a pre-emptive outline for what financial activities a firm would undertake, which would be amended in real time in order to conform to the prevalent global business environment at the point in time. Suffice to say, a budget only sets the directive action plan for an organization; the actual activities of the organization are determined in real time. However, the direction offered by these budgets is critical in the working of an organization. (Welsh et al, 1981) A major argument against the budgeting process is that it leaves an organization susceptible to inertia towards change. That certainly can be believed given that any budget that is formulated would take into account the activities of the organization that were conducted in the previous financial term. Therefore, the influence of historical imperatives will always leave a critical imprint on any budget that is to be formulated. Hence, it can be extrapolated that any organization which chooses to bring an organizational change would have to alter its budget in a way that it does not affect the future perceptions of the company. As an example, if a heavy arms manufacturing company decides to expand into the aircraft after-sales services industry, then it would have to alter its budget in a significant way as the imprints of heavy arms manufacturing would have greatly influenced the budgeting process and the subsequently created budgets. However, a major argument against this criticism is the zero-based budgeting scheme whereby any budget can be created from scratch with not informational imperatives from the previous activities of the organizations. It is certainly true that the effect of previous activities would take a greater time to wane; however, by the sheer force of numerical alterations, the inertia towards change can be greatly reduced in an organization by this process of budgeting. (Horngren et al, Seventh Edition) Conclusion: To conclude, this paper has appropriately shed light on the budgeting process and its value to an organization. As with any argument, there are critical counterarguments, some of which do remain unchallenged; however, from a holistic point of view it is can be easily gauged that budgets play a very important role in management control systems and their influence cannot be denied, at least for organizations that are operating in the current global business environment (Ness et al, 1995). Bibliography: 1. Abernethy, M., Chua, W., Luckett, P., and Seleto, F. (1999). Research in Managerial Accounting: Learning from others experiences. Accounting and Finance, 39 (1), 1-27. 2. Churchill, G. (1991). Marketing Research: methodological foundations. 5th ed., Dryden Press, USA. 3. Demski, J. (1994). Managerial Uses of Accounting Information. Kluwer Academic Publishers, USA. 4. Gitman, L., and Forrester, J. (1977). A survey of Capital budgeting techniques used by major US firms. Financial Management, 6(3), 66-71. 5. Harris, M., and Raviv, A. (1996). The Capital Budgeting Process: Incentives and Information. The Journal of Finance, 51(4), 1139-1174. 6. Harris, M., and Raviv, A. (1998). The Capital Budgeting and Delegation. Journal of Financial Economics, 50(3), 259-289. 7. Hasan, I., Shao, L., and Shao, A. (1997). Determinants of Capital Budgeting Strategies: An Econometric Analysis of U.S. Multinational Subsidiaries. Multinational Business Review, 5(1), 68-70. 8. Modigliani, F., and Miller, M.(1958). The Cost of Capital, Corporation Finance, and the Theory of Investment. The American Economic Review, 48(3), 261-297. 9. Pindyck, R., and Rubinfeld, D. (1998). Econometric Models and Economic Forecasts. 4th Ed., McGraw-Hill International, Singapore. 10. Ross, S. A., Westerfield, R. W., and Jaffe, J., (1999), “Corporate Finance” Irwin McGraw-Hill, Fifth edition. 11. Welsh, J. A. and White J. F., (1981), "A Small Business Is Not a Little Big Business," Harvard Business Review, Vol. 59, No. 4, pp. 18-32. 12. Hilton, Ronal W., Managerial Accounting, Second Edition, McGraw-Hill, Inc., New York, 1994. 13. Horngren, Charles T. and George Foster, Cost Accounting (A Managerial Emphasis), Seventh Edition, Prentice-Hall International Editions. 14. Ness, Joseph A. and Thomas G. Cucuzza, “Tapping the potential of ABC”, Harvard Business Review, Vol. 73, Iss. 4, July-August 1995. Read More