Advantages of Budgetary Control for Corporation - Essay Example

Budgetary Control Budgetary Control Budget is an accentuation for the planned expenses and revenues for a certain period of time. It allows planned flow of resources leading to their efficient allocation and optimization of return (Steiss and Nwagwu, 2001). These budgets have also become a tool for evaluating the organization’s performance and success of the managers and their ability to go by the planned resource allocation. As a communication of the management’s expectations from the managers and lower level employees within the prescribed limits, budget was also said to be a reason why employees tend to refrain from innovating and being creative at work. Budgetary control is one of the two kinds of controls in an organization, the other being financial control. According to Ryan (2006), Budgeting control involves the planning, control, co-ordination and motivation of departmental estimations in monetary terms. It incorporates the comparison of planned and actual budget in between the period to ascertain whether the allocation is going as planned or the reasons for disparities if any. Institute of Cost and Management Accountants (CIMA) defines budgetary control as the act of continuous monitoring of actual budget with the planned one in order to find out discrepancies that can be eliminated through either individual action or by incorporating the effects of changes in revision (Botten, 2007). The practice of Budgeting has been deeply injected in the corporate system in today’s world and has fast become an anecdote for the performance of a corporation due its capability to highlight the difference that lies between the planned and actual outcome (Hansen and Otley et al., 2003, pp. 95--116). This paper will shed light on whether the practice of budgeting is really an indicator for an organizations performance or a myopic strategy that allows the upper management to take control of the activities of the subordinates in an organization, without accounting for the possible deviations that may occur in today’s dynamic environment. Since budgets do not consider the variations during the period it is designed for and its impact, there is a debate regarding its effectiveness as one of the parameters for performance evaluation. Budgetary control has the following features: - Support for business policies: Budgets involve the allocation of resources according to the policies of the business. Major emphasis is given on the business’s core competency that differentiates it from the competitors, thus, it can be said that the extent of resource allocation in different aspects of the business compliment the overall business policy. - Forecasting: along with past performance, the forecasting tool is used to estimate the inflow and outflow of resources. Thus, this tool is an important feature in deterring the estimated budgetary components. - Reflection of management’s philosophy. The act of budgeting also reflects the management style as it can either involve participative feedback from the departments in order to come up with a realistic and achievable or a rigid top-down approach. - Budget Committee: a budget committee is formed to research and form a budget that trult reflects the flow of resources. Periodic revision of the budgets is in the hands of the members of this committee. - Efficiency: budgeting control leads to optimum utilization of resources according to a plan. Thus, it leads to overall organizational efficiency and business success. - Sources of motivation: Budgeting control acts as a source of motivation as it reflects the estimated revenues and the cost analysis. The managers have a clearer idea about what to spend where and this gives them guidance in the normal course of business. Budgetary control has several advantages as well. Apart from guiding the managers about the allocation of resources over the period it also encourages co-ordination between the different organizational levels and departments and improves communication amongst employees at different levels. Budgetary data is a record of the organization’s performance, planning and activities which serves as a source of guidance for the existing and future managers. It enables the formation of strategic plans that reflect the anticipated revenues and expenses, and their ideal allocation for the business success and efficiency. Apart from that, in the recent practices it also allows revision as a corrective measure to accommodate any changes or externalities that had not been accounted for previously. As far as limitations and disadvantages are concerned, some researchers back their notion that budgetary control makes an uncertain determinant for an organization’s success by some valid points. For example, if followed rigidly, budgetary control can lead to lack of innovation and motivation at different levels as it accounts for a fixed amount of resource allocation and minimal employee participation in the budgeting process (Hofstede, 1968). It can cause internal conflicts in the form of departmental wars for more allocation etc. this is not a healthy practice for any business as it can only function at its best when the whole organization is united in its purpose as a whole. Budget formulation and control is a time consuming process since it is costly and comprehensive to estimate every department’s need requirements and the extent to which they can be catered to. Estimation and forecasting are a science that involves complex assumption patterns and calculations. Most importantly, budgeting is based on estimated flow of resources and its application cannot be guaranteed a 100%. This is because many new factors come into play each time and it need to be revised to account for these changes. Linking the effective actual budget with the estimated one in order to determine the organizational performance is one major mistake that is made at the time of evaluation. The use of budgetary control in performance management In today’s world organizations use several dimensions to evaluate their performance. One of the most valued one is budgeting. Organizations use it as an evaluation parameter to determine the extent of deviation from the planned budget and whether the end result had been according to the success criteria determined. It has become an integral component for the evaluation of performance and many studies have been conducted to support of criticize this stance. This paper is aimed at highlighting the different business aspects that budgetary control impacts and how it can be blended with other indicators to form a more comprehensive performance evaluation strategy. The advantages mentioned above will be linked to the limitations of the capital market for the implementation of budgetary controls. Organizations are constituted of several activities and departments that are co-related with each other in their purpose to accomplish the organizational goal. However, changes in one sector can impact one department’s performance and deviation from the planned budget. This is one of the negative aspects of budgeting that have been highlighted. To counter this, the suggestion of involving the employees themselves was proposed. For example enabling departmental heads, to ascertain the flow of resources in their department was given. However, there emerged a speculation that that may form an artificial cushioning for themselves at the time of budgeting so that they can absorb variations and not deviate from the planned. This called for a detailed study to ensure that the organization as a whole can work with proximity with the planned budget. The limitations of budgeting control for the capital markets were also a concern. Since Capital markets involve the inflow of investment and this flow is generally non-predictable, Wollcott (2003) suggested the use of a new kind of budget called the rolling budget. As the name suggests, it breaks the period into period quarters and amendments are possible at each quarter. This enables achievable targets to be set for a shorter duration so that even f any discrepancies occur, they can be accounted for in the next periodical budget within the master budget. This concept of a flexible budget and shorter budget cycles has made the budgeting control an important tool of communication of the organization’s market soundness. It also reflects the company’s aspirations to the stakeholders, strengthening their relationship. Capital markets and stakeholders are two very important aspects of any corporation’s management. Since the capital markets or investors look at the budget variances to determine the company’s position and the stakeholders look at budget allocations to estimate the successful operations for the period, they look at budgetary controls to make decisions regarding investing and buy/sale of shares (Narayanan, 2009). In today’s world, capital acquisition is an important aspect and so the capital markets have to be satisfied through the operations (Durnev and Morck et al., 2004, pp. 65--105). Shareholders have the company’s value in their hands and if they speculate losses due to discrepancies in the actual and planned budget, they might indulge in collective sale of shares, bring down the share price and ultimately the value of the company. Needless to say, budget will always be an essential performance indicator for the business, its stakeholders and the financial markets. However, managers have to make a conscious effort to keep in mind the ultimate goal of the company that is the customers and market. Conclusion and Suggestions: There is no denying the fact that budgetary control has many advantages for every corporation. It acts as a guiding tool for the managers and is a reflection of the organization’s soundness in its performance and operations. However, the classical budgeting model does not take into account the changes and variations that are unavoidable under the fast-paced challenges in today’s market. According to a study, “budgetary criteria in performance evaluation: a critical appraisal using new evidence”, the first step towards minimizing the distortion caused by the budgeting control on performance is to account in it the changes and variance that may occur. In this way it provides enough cushioning for the budget to absorb unanticipated occurrences and keep the budget on a realistic ground. The second step can be to invest in research regarding the causes of these changes and variations in budgets beforehand and focus on controlling them through a strong contingency plan. Lastly, the emerging changes in the accounting and management practices should be applied and the examples available worldwide regarding the expected changes can be used to form a general assumption of variations that may occur, incorporating this general assumption pattern in the budgeting control measures (Otley and Pollanen, 2000, pp. 483--496). That being said, it cannot be denied that budget control will always be a core aspect of performance evaluation. New control mechanisms that are being adopted by corporations that consider the different possibilities in order to minimize deviation from the planned budget are becoming a more appropriate tool for performance evaluation (Diamond, 2003). References: Botten, N. 2007. Management accounting. Oxford: CIMA. Wollacott, M. (2003) What Is a Rolling Budget?. [online] Available at: http://www.wisegeek.com/what-is-a-rolling-budget.htm [Accessed: 6 Jul 2013]. Ryan, B. (2006) Budgeting, the Individual and the Capital Markets: A Case of Fiscal. [e-book] Egham: School of Management, Royal Holloway University of London. p. 5. Available through: digirep http://digirep.rhul.ac.uk/file/f61e76cc-1894-03c9-76bf-0bb22df3547b/1/0601.pdf [Accessed: 1 July 2013]. Steiss, A. W. and Nwagwu, . O. C. 2001. Financial planning and management in public organizations. New York: Marcel Dekker. Otley, D. and Pollanen, R. M. 2000. Budgetary criteria in performance evaluation: a critical appraisal using new evidence. Accounting, organizations and Society, 25 (4), pp. 483--496. Hofstede, G. H. 1968. The game of budget control. London: Tavistock. Narayanan, V. G. 2009. Preparing a budget. Boston, Mass: Harvard Business Press. Durnev, A., Morck, R. and Yeung, B. 2004. Value-enhancing capital budgeting and firm-specific stock return variation. The Journal of Finance, 59 (1), pp. 65--105. Diamond, J. 2003. From program to performance budgeting: the challenge for emerging market economies. [Washington]: International monetary fund. Hansen, S. C., Otley, D. T. and Van Der Stede, W. A. 2003. Practice developments in budgeting: an overview and research perspective. Journal of management accounting research, 15 (1), pp. 95--116. Read More