The Importance of Budgeting Within the Engineering Sector - Essay Example

The Importance of Budgeting Within The Engineering Sector The importance of budgeting in any business sector cannot be overemphasized. It is most critical especially during the first two years of the business when one of every two enterprises is expected to fold, based on an accepted trend (The Times 100, 2010). Companies in the engineering sector definitely stand to benefit from the strategic use of budgeting to ensure operational efficiency and financial well-being. Budgeting may eat up a substantial amount of the working time of concerned company officers. In the end, however, the perils that can be avoided through the diligent use of budgeting make it a worthwhile management tool. Since there are more ways than one for a company to achieve a certain level of sales, it is for its best interest that the mechanism that goes with the least expenditures be carried out. In the light of the limited resources that are available for the company’s use, a budget becomes a systematic tool for allocating resources. (Wildavsky, 1986, p. 8) A number of factors named as causes of business failure can be avoided by designing a well-planned budget and by maximizing the benefits of having one. These factors include poor marketing, cash flow problems, poor business planning, lack of finance, failure to embrace new technologies and new developments, poor management and lack of clear objectives. (The Times 100, 2010) Though budgets are prepared periodically, they are best prepared as zero-based. The present and previous years’ sales and expenses figures – albeit useful as bases for the next year’s projections – must not be simply copied or updated. Budgets vary from industry to industry, given the prevailing peculiarities that govern the financial planning and reporting of the respective industry players. Needless to say, revenue sources and types of expenditures differ amongst industries. In the engineering sector, the cost areas to be controlled and monitored are classified into five categories: namely, contractor engineering work hours and other office costs; purchase of equipments; detailed design of bulk materials; procurement of bulk materials; and, project changes (Clark & Lorenzoni, 1997, p. 189). From the Rhsmith.umd.edu website Budgeting helps to improve a company’s marketing design. In the process of formulating the company’s projected revenues and expenditures, the net income or loss figures that result from targeted sales levels are computed. It is then determined whether or not the targeted sales would yield the desired profitability level. As needed, sales targets are adjusted to bring about better operating results. From the Rhsmith.umd.edu website Budgeting ensures that the company’s cash flows remain healthy and well-designed. Through budgeting, the company’s resources are allocated effectively and efficiently. The use of budgets signifies a company’s commitment to its objectives and it provides a sound device for monetary control. (Raiborn, Kinney & Prather-Kinsey, 2006, p. 307) Companies can end up with liquidity problems as a result of ill-timed expansion or of poor collection mechanisms. A fast-growing company would do well to construct budgets that would ensure there is sufficient cash to be used in its operations. Scarcity of liquid resources has driven companies to avail of high-interest loans that eventually led them to declare bankruptcy. (White, Sondhi & Fried, 2002, p. 109-110) Budgeting addresses poor business planning by giving the management a clear picture of operating results that follow low levels of productivity and marketing success. Budgeting directs the management’s attention to possible insufficiency of liquid resources at certain times during the operating year. Diligence and utmost care must be practiced in the formulation of the final budget figures. The projected revenues have to be based on reasonable assumptions and the projected expenditures must cover all that will be incurred. If, in the end, the consolidated budgeted statements of income and expenses report net losses for the company, then the management ought to arrest the foreseen dilemma by reworking on the targeted income and expense figures. Budgeting enables management to look into the acquisition of new technologies and new developments. Capital budgeting involves the identification, analysis and selection of capital investment opportunities that are available to the company (Helfert, 2000, p. 253). It pertains to capital expenditures that involve relatively significant amounts – this makes it all the more critical that such investments be thoroughly planned out. Capital budgeting requires the computation of future earnings that can be generated by the purchase of a specific asset. These are taken into consideration in the making of such major decision to acquire the asset or not. (Brigham & Houston, 2000, p. 388) A thorough project analysis includes the application of forecasting methods and risk determination, and they all are taken into consideration in the making of the budget for the project. (Dayananda, Irons, 2002, p. 7) Even poor management can benefit from the use of budgeting. Budgets provide concrete guides in securing the financial viability of the company’s operations. Lack of clear objectives is, as well, solved by adequate budgeting. When everybody in the company cooperates and does his share of attaining the budget figures set for a given year, it is as good as having established definite and concise targets and goals for the company. In particular, production budgets provide standard figures for the various segments of the company’s operations. Budget variances represent the gap between the total actual costs and the budgeted costs (Raiborn, Kinney & Prather-Kinsey, 2006, G-2). These figures serve to help management maintain deviations from the set standards within minimal levels thereby resulting to efficient company operations. Below are the procedures that summarize how direct materials variances are determined and then used by management to make decisions that are critical to the company’s overall operational efficiency. Other variances – direct labor variances, overhead variances, etc. – are similarly computed and used by management to incur consistent and minimal production costs. Illustration by Anna Rovira Beavers The foregoing discussion provides concrete situations when the budgeting can actually help keep a company in good financial condition. In all business sectors, budgeting has become an essential tool that is widely used during both the planning and implementation stages of the company’s operations. References Helfert, E. (2000). Techniques of Financial Analysis. Boston, USA: The McGraw-Hill Companies, Inc. Raiborn, C., Kinney, M. & Prather-Kinsey, J. (2006). Cost Accounting. United Kingdom: Thomson Learning. Brigham, E. & Houston, J. (2000). Fundamentals of Financial Management. United Kingdom: The Dryden Press. White, G., Sondhi, A. & Fried, D. (2002). The Analysis and Use of Financial Statements. New York, USA: John Wiley & Sons, Inc. Wildavsky, A. (1986). Budgeting: A Comparative Theory of Budgetary Processes. New Jersey, USA: Transaction Publishers. Clark, F. & Lorenzoni, A. (1997). Applied Cost Engineering. New York, USA: Marcel Dekker, Inc. The Times 100. (2010). Business Failure. Retrieved May 21, 2010 from http://www.thetimes100.co.uk/theory/theory.php?tID=320. Phillips, G. Capital Budgeting. Retrieved May 22, 2010 from http://www.rhsmith.umd.edu/faculty/gphillips/courses/Bmgt640/Cap_bud.pdf. Dayananda, D., Irons, R., Harrison, S., et al. (2002). Capital Budgeting: Financial Appraisal of Investment Projects. Retrieved May 22, 2010 from http://catdir.loc.gov/catdir/samples/cam033/2002019249.pdf. Beavers, A. R. (2007) Managerial Accounting: Standard Costing and Variance Analysis. Retrieved May 22, 2010 from http://www.laney.peralta.edu/Projects/30604/ Business%201B%20-%20Managerial%20Accounting//Chapter_22.pdf. Read More