2. Advantages of budgeting
2.4. Performance evaluation
2.7. Authorisation and delegation
3. Budgeting impact on employees
3.1. Type of budget
3.2. Involvement in budget decisions
3.3. Target setting and evaluation
In order to achieve their goals and objectives most companies make use of a budgeting technique. According to the Chartered Institute of Management Accountants (CIMA) budget is “a quantitative expression of a plan for a defined period of time” (CIMA Official Terminology, 2005). Usually budgets are expressed in financial terms and prepared for one year.
Depending on the nature and business of the company, different types of budgets, such as incremental, zero-base budgeting (ZBB) or activity-based budgeting (ABB), can be adopted. However, usually the budget setting will commence with preparing the limiting-factor budget which will frequently be the sales budget with other budgets, such as production, direct labour and cash budgets, being prepared subsequently. After coordinated revisions these are added to a master-budget consisting of a balance sheet, profit and loss account and a cash-flow statement.
Despite the fact, that budgeting process has been often criticized because of its rigidity, short-term focus and bureaucratic and time consuming nature (Bunce/BBRT, 2004), it still provides many benefits to the company if implemented correctly. In fact, participants from the Better Budgeting forum came to conclusion that budgeting has been evolving and changing to better meet the requirements of today’s highly competitive and very dynamic environment (Jackson and Starovic, 2004a).
2. Advantages of budgeting
It is vital for a business to plan for the future. Budgeting is regarded as an ideal device for converting company’s long-term strategic plan into financial terms (Wood and Sangster, 2008a). In addition, budgeting process forces managers to plan and look ahead (Emery et al. 2004a). By doing so management can identify potential problems, generate new ideas and eliminate bad ones as well as prepare for contingencies. Identifying problems early can help to prepare better and find a more suitable and rational solution; imprudent and hasty decisions can thus be minimized (Drury, 2005a). Proactive planning of the cash budget is particularly important in order to avoid insolvency. This is especially vital for smaller sized companies. Finally, it is well known that a good planning can considerably reduce costs, particularly in project-based environment (Dunbar and Kemp, 2003).
If a company wants to be successful, its various departments and sections have to work in harmony with each other towards common goals. A budgeting process helps to coordinate and link the different functions together, and ensure that all the activities are complementary in terms of quantities as well as time, and the departments do not conflict with each other. (Atrill and McLaney, 2007a). In the budget setting process managers are also compelled to identify and deal with potential constraints and conflicts between the departments. This could lead to a better cooperation and increased performance.
If the company has adopted a participatory budgeting style, this could help to improve information sharing between various levels of management. As Hayes and Luecke (2002a) points out, top management might often not be in touch with the realities of the processes in different departments or markets. Budgeting could help to close this information gap and improve coordination.
The control function of budgeting system has been regarded by financial as well as non-financial managers, alongside the planning and performance evaluation, as the most important benefit for the company (Dugdale and Lyne, 2004). By collecting information on actual performance and comparing it with the budgeted amounts, managers can establish which activities are in control and which are not. This process enables managers to use ‘management by exception’ technique which allows them to focus attention on the activities or subordinates that have failed to achieve the budget (Drury, 2005b). This feedback process enables corrective actions to be taken in order to bring the operations back on track. However, Atrill and McLaney E. (2007b) points out that budgets are useful for control reasons only as long as they are achievable. They further argue that a clear distinction between individual managers’ areas of responsibility, quick and relevant reporting and top-management commitment are necessary for successful budgetary control.
A further advantage of budgeting is that it allows recognizing trends both, externally, such as market changes, and internally, such as unexpectedly rising costs.
2.4. Performance evaluation
Budgets can be used to evaluate manager’s performance by measuring how successful the budgeted plans have been achieved. Through reward systems based on the performance evaluations can act as a motivator to achieve the budgetary goals. Hayes and Luecke (2002b) suggest that the evaluations can also be used as a basis for such decisions as future assignments, career advancements or future resource allocations. In addition Drury (2005c) points out that the manager may wish to evaluate his or her own performance in achieving goals that they possibly have helped to set. However, there are also behavioural issues connected with evaluation methods which will be discussed in the next chapter.