Budgeting: Benefits and Difficulties

Production Budget

A production budget is only developed from the sales budget after considering a policy on closing stock level. The production budget in quantity will then be translated into budgeted requirements for the major production resources like raw materials and labour. The Production Budget in this case is;

Month September October November December Total
Units 500 300 200 200
Opening stock 125 75 50 50
Current month requirements 375 225 150 150
Closing stock 75 50 50
Production budget 450 275 200 150 1,075

Raw Materials Budget

The budgeted quantities must be converted in terms of raw materials and components so that a purchasing plan can be developed. If semi-manufactured components are to be purchased from outside suppliers they must be ordered in good time so that they are available when necessary. Consideration must be given to materials which are in short supply and the effect on the budgets determined. The buyer must appraise market conditions and recommend whether stocks are to be increased or reduced. The budget will be prepared to show the quantities and values of materials required for budgeted production, taking into account.

Raw Material purchase budget

Raw materials September October November December Total
Material A
Production units 450 275 200 150 1,075
Ratio in production units 3 3 3 3
Requirements of material A 1.350 825 600 450 3,225
Price per kilo 5 5 5 5
Total value of material A 6,750.00 4,125.00 3,000.00 2,250.00 16,125.00
Material B
Ratio of material B in one unit of production 4 4 4 4
Requirements of material B 1,800 1,100 800 600 4,300
Price per units 3 3 3 3
Total value of material B 5,400.00 3,300.00 2,400.00 1,800.00 12,900.00

Budget Definition

A budget is a projected financial or resources of a firm for a certain future period. Budgets can be about expenditure, income and employment of income.

Budgeting is an important aspect to any business organization for its success and growth. Businesses set out their goals and objectives that they want to achieve and focus on how to achieve them as they prepare for the future. Therefore budgeting is necessary for any organization as it is used to estimate the income and expenditure of a business or part over a specified period of time.

The manager’s responsibility is to plan for the future and decide on what is to be done and how to achieve the company goals. The budget assists the management to achieve this objective since it is a detailed plan and outline of what the organization wishes to achieve using of figures and detailed action plans. The manager’s performance will be improved through performing individual roles after having a predetermined task. A successful budget is prepared and planned well by managers and these managers should understand and study all factors that make a perfect budget.

A budget is a detailed plan and outline of what the organization wishes to achieve using figures and detailed action plans. It is such a formalized system of planning, forecasting, monitoring, and controlling the use of resources, which managers use to achieve the company’s objectives both in the public sector and private sector because main responsibility of a manager is to plan for future and decide what should be done and how it will be achieved. After having a set task, managers can perform better by performing their individual roles. Dunbar (2003) says Managers of any type of organization must be able to prepare and understand a perfect budget. According to Shim and Siegel (2008), managers must learn all tools which can make the budgeting process easier.

Budgeting has a number of different roles in the management. These roles have a number of benefits, but sometime they cause conflicts. Emmanuel and fellows (1990) say that a budget has five roles, “a system of authorization; a means of forecasting and planning; a channel of communication and coordination; a motivational device; a means of performance evaluation and control, as well as of providing a basis for decision making”.

Benefits of a Budget

Budgeting can be used as a means to exercise control

Control can only take effect where there is a plan because no one can be said to be in control of a situation if he does not know where he is going. Control takes effect by measuring the result of the activity and comparing the actual results against the budget. Where there is a variance from the actual which is significant the management takes action to correct it (Emmanuel and Otley, 1990).

A communication and coordination tool

Budget making requires detailed information for almost all departments of the organization. In the process of meeting this information needs, these departments work as a team influencing coordination among them. The departments include marketing, human resource management and production. In addition this can act as a motivator to the departments if the planned targets are achieved. Each department in an organization should participate for making a perfect budget. This is so because this information will be discussed in detail and clarified if necessary. It is the manger’s responsibility to work towards the company’s overall objective. Therefore this co-ordination will ensure that all departments are working towards the same objective. Further, it will help the organization to know that the supply of its resources is balanced to each department. For example, if the production department of a company wants to expand its production capacity by renting another facility, its manager needs to co-operate with marketing manager to invest heavily on marketing to create market for an extra production.

Strategic planning and implementation of plans

The Company’s strategy analysis should include budgeting as its integral part. Strategy indentifies how a company matches its own strengths and weakness in a competitive environment to accomplish its objectives. Both short-run and long-run planning of a company is affected by strategy. And budgets are used to express long-run and short-run of a company planning. Plans and strategies can be changed by plans through budgets. Further, these feedbacks can be positive or negative requiring the manager to revise their plans and strategies.

Motivating managers and employees

According to the research, budgets that are changing are considered to improve performance. A budget motivates employees and managers work hard to achieve organisational goals. Employees aim to achieve the monitored performance. Managers are encouraged to set challenging goals to their employees which are achievable. Unachievable goals are not motivational since employees avoid failure aspect. But achievable goals are motivational and satisfying to both managers and employees.

Problems of Budgeting

For budgeting to be successful, it must be put into the correct use. If budgeting is wrongfully used, it can bring some misunderstanding. The organization can face some problems if inaccurate estimates or forecasts are used. For example if wrong assumptions are used as raw materials figures can cause a lot of problems to the management.

In addition, conflict may arise in the course of budget making process because of different roles in management. For example the managerial role to comprise on increased production may conflict with the managerial role to maintain good quality. Further, in the process of using a fixed budget some of its factors can be easily evaluated but others are difficult to assess. In reality the process of evaluation is more complex since these indescribable factors are not easy to assess. For example, quality innovativeness, and custom services are some of those things tha are hard to evaluate. But factors like sales, productivity and market share are easy to evaluate (Hope and Fraser, 2003).

Behavioural aspects of budgeting

Some behavioural issues arise during the budget making process. While drafting and planning a budgeting system these issues needed to be considered because budgets can have implications for human behaviours and budgeting can have negative impact on employees’ performance. There is a possibility that people will focus only on objectives set by the budget, regardless of whether or not it is managerially desirable. This means that employees would set out to exploit the rules of the budgetary control system to boost their individual performance and would not take care of other areas that are not monitored by the control system. Drury (2000) found that “…actual behaviour may be modified so that desired results appear to be obtained, although they may have been achieved in an undesirable manner which is detrimental to the firm”. Furthermore, budgeting can give managers a tool to check the performance of their team members. It’s considered that, the setting of performance measures mush match the setting of new strategies and objectives and the implementation of action plans for the company.

During the process of budgeting, some behavioural aspects may arise. Proper consideration of these issues should be taken in the process of developing and planning a budgeting system since budgets can affect human behaviours and as a result, a negative impact on employee performance may arise. In this case, people will be forced to work extra hard to achieve budget objectives without considering whether they are desirable to the management. As a result, employees will aim to improve their performance through exploiting the rules of the budgeting control system without considering areas that are not monitored. This modification of the actual behaviour to suit the desired results is detrimental to the company. This situation may lead to alack goal congruence. Further, the management can use budgeting as a tool to measure the performance of its employees. In this case, it is considered that setting of new strategies, objectives and the implementation of action plans for the firm must be in accordance with the setting of performance measures (Welsch, Hilton and Gordon, 1988).

Another behavioural problem which should be considered while setting budgeting control system is control which is set by the system. Control if not carefully applied can cause negative attitude. In addition, if control is applied in a way that it is impossible to meet its targets and strictly applied then it cause behavioural problem. For a control system to be successful, it is important to apply it with a lot of care.

Behavioural problem can be further dealt by participation. The management must work as a team with its employees to achieve the set targets in the budget. Participation is one of the factors that influences budget performance and attitude of the budget. Employees must be dynamic towards changes for the company to achieve its targets. Further, participation improves coordination within the firm as employees and management works together to achieve a common objective for the firm. In addition, it improves the confidence level of employees to the firm (Emmanuel, Otley and Merchant, 1992).

Communication is an important aspect in developing budget. It is a very important factor of management. Communication can be defined as the exchange of information between two parties which brings about mutual understanding. The channels of communication within the firm must be clearly elaborated. For the firm to work efficiently and effective, proper line of communication must be in place so that each department is well informed about its role towards the budgeting goals. The approach in which the person who receives information may be affected throughout the firm may bring the issue of behavioural problems.

To measure the performance of managers, companies used budgets to motivate them for achieving goals. Further, the company uses budgets achievement to improve their motivation by attaching different rewards and penalties to these results.

Conclusion

If budgeting is properly applied it can be beneficial and valuable to the management. It is however, not without dangers unless caution and intelligence are exercised both in developing and implementing the plans to achieve them. A business is a dynamic thing. Conditions both inside and outside the company are constantly changing. A budget is a framework and should not be allowed to hinder, by undue rigidity, the development of the business. New opportunities must be grasped and the budget must not be used as an excuse for rejecting them. Budgeting control should ensure that new and unforeseen opportunities are channelled to members of the organization capable of giving them proper consideration (Drury, 2000).

From the above, we tried to establish the benefits and problems of budgets and behaviour aspect of budgeting. We have further established that no matter what the role the budget served, no single budget will serve all the functions in the company. And the different roles may well conflict each other. The mangers’ executive responsibility is to work towards a common objective of business through planning, controlling, monitoring and forecasting.

Reference List

Drury, C. 2000. Management and Cost Accounting. London: Business Press Thomson Learning.

Dunbar, E. (2003). Budgeting for Managers. New York: McGraw-Hill Professional.

Emmanuel, C. R., & Otley, David T. (1990). Accounting for management control. London: Chapman and Hall.

Emmanuel, C., Otley, D., & Merchant, K. (1992). Readings in Accounting for Management Control. London: Chapman & Hall.

Hope, J., & Fraser, R. (2003). Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap. Boston: Harvard Business School Press.

Shim, J. K., & Siegel, J. G. (2008). Budgeting Basics and Beyond. New Jersey: John Wiley & Sons Publication.

Welsch, G., Hilton, R., & Gordon, P. (1988). Budgeting: Profit Planning. New Jersey: Prentice-Hall.