Budgetary Control and Performance Management - Essay Example

Budgetary Control and Performance Management Introduction Recently, there has been an upsurge in the number of business managers using estimates of income and expenditures for a defined period to set targets. These business managers use the budgets to financially explain the objectives of the business over a period, generally given as one fiscal year. Budgetary control is therefore an important element in organizational control especially concerning performance management. Budgetary control, defined as the process involving planning, control, and coordination through money values and departments within an organization. At the same time, however, the relationship between the organization and the capital market has been growing gradually, bringing to the forefront several problems, which require solutions. The purpose of this paper is to discuss the growing use of budgetary control in performance management by defining and explaining its benefits and limits in regard to the capital market, and how those limits can be overcome. Budgetary Control and Performance Management Budgetary control has been increasingly utilized as the main integrative control mechanism for most organizations especially in the recent past (Otley, 1990). Budgetary control is a financial representation of the organization’s business plans and objectives, and can be used as a monitor and control mechanism for intricate issues of the plan. It has been argued that in order to have an effective method of planning, it is important to put in place an effective and efficient mechanism of control (Lucey, 1996). The exercise of control in the business enterprise based on standards set out in a budget is what entails budgetary control. Hofstede (1968) offers a simplified definition of budgetary controls as a form of planning developed by the organization entailing its objectives translated into monetary terms. At the onset of the process, a budget is simply a plan in monetary terms while the end result is a control mechanism for measurement. According to van der Stede (2000), the purpose of budgetary control is to provide a formal basis that can be used by the managerial function of an organization to monitor its overall progress and that of individual functions. Monitoring of progress is essential in evaluating the path towards achievement of laid down objectives in the budget. Budgetary controls thus predetermine plans of output and compare predicted incomes with actual outcomes so that the necessary correctives measures can be taken (Bhimani et al., 2012). Budgetary control is a key an essential element that has gained popularity among managers of corporations in ensuring accountability of business operations. Its use has of late been widespread not only in large companies with significant investment but also in small and medium sized enterprises. Companies are increasingly appreciating the need for employing budgetary control in helping in the planning and improvement of overall performance management. Performance management mechanism, in simple terms, is a method employed by an organization to assess the progress towards a specified set of objectives or goals. Performance management entails a set of metrics employed by an organization’s management function to quantitatively analyse the effectiveness and efficiency of its activities (Neely,Bourne and Adams2003). The purpose of a performance management is not to serve as an incentive but rather as a communication and management tool to improve the overall effectiveness of the organization. There is an intricate relation between budgetary control and performance management of the company. Performance management involves deliberate initiatives aimed at ensuring that company goals and objectives are efficiently, effectively and consistently met. By definition, performance management is a strategic and integrated business mechanism intended to ensure the efficiency of companies by developing and improving the competence and capabilities of employees (Armstrong and Baron, 1998). The aim of using budgetary control as a performance management mechanism is to shift the focus from the quantitative value of resources allocated, to the output gained with those resources as a way of measuring performance. Benefits of Budgetary Controls Budgetary control is an important determining factor in performance management. Through budgetary control, the overall performance of an organization can be evaluated or appraised since the budgetary control is essential in translating the managers’ strategic plans into quantitative ones. Basing their decision on the recorded outcomes, business managers are able to conduct a constructive comparison between the actual outcomes with the budgeted plans and carry out an investigation of the reasons bringing about the variations (Miller, 1998). Consequently, managers are presented with an opportunity to consider the feedback and changed conditions after performing an in depth analysis of the causes of the variations. This analysis further presents to the managers leading tips on performance management, whichcan then be used in making new plans intended at improving the performance. Preparation of budgetary control involves the formulation of management standards using quantified ways. This makes the budgetary control easy to asses, and evaluation of the efficiency of the performance of the organization’s employees can be carried outbased on the set standards. This way, budgetary control serves as a means of motivating employees in order to achieve better performance, and further serves as a basis for individual consideration for promotions or incentives. As discussed above, it is evident that budgetary control helps in improving the budget plans including setting objectives and formulating standards. However, it is important to note that the greatest value of a budget is its ability to enable improvement of the coordination and control, which helps in performance management (Bhimani et al., 2012). Therefore it is important that the budgetary control is place should take on board every department in the organization to enable effective coordination hence better overall organizational performance. The budgetary control also ensures easy identification and assessment of any deviation from the projected results. In addition, the budgetary control provides a basis for corrective measures to be taken in order to deal with such deviations. It is useful for an organization to set budgetary controls since they bring about efficiency in the working conditions of an organization by defining a set of target objectives and goals for the organization and availing resources necessary to meet those objectives (Kaplan and Norton, 1992). This is significant since it ensures that every function and employee in the organization is aware of the desired outcomes and has the resources availed to them which thus ensures efficiency. Another important feature of budgetary control is that setting the budget within feasible constraints, usually at a level slightly above the actual results, serves as a constant motivational tool for an organizations workforce (Gregory, 2005). Having proper budgetary control and performance management mechanisms enables reconciliation of employee personal goals with those of the organization. This motivation can be beneficial in encouraging employees in transforming marginal businesses and increasing productivity and overall productivity for the organization. Evaluation of managerial performance is also essential regardless whether there are external assessment schemes in place. Managerial performance is often measures by evaluating the performance of the manager against the budget, and the ability to achieve set out targets often leads to promotions or incentives. Budgetary control thus provides a valuable way of informing the managers of an organization of their progress in meeting target objectives that have previously been set by them. Budgetary controls, if not effectively used, are merely a set of exercises in calculation (Maltz,Shenhar&Reily, 2003). The authors state that budgets are drawn as part of a system of budgetary control, which entail basic ideas of what the organization intends or desires to achieve. The budget serves as an aid to the organization in achieving these ideas upon which budgetary control checks to verify whether expenditures are on course. Challenges and Solutions For budgetary control to be effective in improving performance, it is essential that the budget is properly made is neither too high nor too low. This is an important factor to be considered when formulating budgetary controls because setting the budget too high creates a unattainable feeling within the organizations workforce which is unfavourable for the management function of the organizations to motivate employees to fight for the goals. Setting a very low budgetary control would demoralize the employees towards achieving higher levels of efficiency. Therefore, proper and appropriate budgetary controls are very important for the managers to ensure that employees perform at their best. There are challenges that may arise during the implementation of budgetary control despite the existence of sound guidelines in terms of planning and control or objectives (Lowe,Chua &Puxty, 2002). The source of such challenges are likely to not only emerge from within the organization but are also brought about by external factors within the environment that the organization operates. Nowadays, it is common practice that accountability in organizations is driven down to the individual level so that performance management is easier to conduct (Simons, 1995). The challenges that are associated with budgetary control include frequent variations between the estimated and actual results due to changes in conditions and poor forecasting.Irrelevance of the budgetary control to current situations because of changing circumstances given the fact that budgetary controls are formulated based on existing circumstances; and creation of inertia and lack of flexibility as a result of the existence of documented plans (Lucey, 1996). A proper budgetary control should therefore be a useful plan that integrates the different human resources, capital and several other factors within the organization. A good budgetary control can also serve as a method of increasing motivation, efficiency, performance, overallbusiness productivity, and acts as an effective performance management tool. In order to make the budgetary control the function of directing and managing the organization’s workface at every level of the company’s structure, it is imperative that the budget so formulated portrays a clear reflection of the actual existing conditions of the organization. In this regard, in order to achieve better performance management departments or various functions of the organization, the formulation, coordination and fulfilment of the budgetary control should be carried out according to the specific needs of individual departments. Therefore, in order to ensure that budgetary control is effectively implemented, it is important to ensure that the mechanisms developed as a measure of performance are clear and easily understandable by all stakeholders, and adequately elucidates on how performance is being evaluated. The budgetary control should also accurately represent what is being assessed, and remains relevant to the cause. Moreover, reliability of the budgetary control should be ascertained by ensuring that the information is devoid of errors, unbiased, and that the results are easy to implement across departments. Conclusion Budgetary control has in the recent past emerged as an effective mechanism used by managers in enhancing the performance of organizations in many ways. The process of budgetary control provides managers with a formal platform for observing the actual results against the estimates as set out in the budget, and investigating the deviations so that appropriate corrective actions can be taken to ensure achievement of the set out standards. The overall effect of budgetary control on performance management is to create a unit intended to lead to increased profitability. Most organizations regard budget preparation as an on-off event based on extrapolation and additional process. However, this is usually done without proper research or studies being carried out, leading to arbitrary budget cuts based on subjective judgment. Doing so has the effect of rendering budgetary control to its intended purpose. Therefore, the use of budgetary control should be prompted to aid in eliciting a better performance of the organization. This can be achieved if solutions to the challenges associated with budgetary control are developed including ensuring that the control remains relevant, is understandable and is a true representation of the actual conditions of the organization. References Armstrong, M. & Baron, A. (1998). Performance Management: The New Realities. Institute of Personnel and Development. Bhimani, A., Horngren, C. T., Datar M. S., & Rajan, M. (2012). Management and Cost Accounting. Financial Times Press. Gregory, J .N. (2005). The End of Traditional Budgeting. Performance Management. 18(1), 27 39. Hofstede, G.H. (1968). The game of Budget Control. 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The Relationship Between Two Consequences of Budgetary Control: Budgetary Slack Creation and Managerial Short-terminism. Accounting Organizations and Society, 25, 609-622 Read More