Budgetary Systems

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Producing budgets

A budget is a quantitative detailed plan prepared for a specific time period. It is normally expressed in financial terms and prepared for one year.

Forecasting is a technique used to arrive at estimates based on judgment and experience.

The main objectives for producing budgets

  1. To Compel Planning

    One of the key purposes of a budgeting system is to require planning to occur so that the organisation’s objectives are achieved.

  2. To Co-ordinate Activities

    Budgeting is a method of bringing together the activities of all the different departments into a common plan.  

    If an advertising campaign is due to take place in a company in three months’ time, it is important that the production department know about the expected increase in sales so that they can scale up production accordingly.

  3. To Communicate Activities

    The budgeting system facilitates communication within the organisation both vertically (for example between senior and junior managers) and horizontally (for example between different organisational functions).

  4. To establish a system of control

    One of the most important purposes of a budgeting system is to facilitate cost control through the comparison of budgeted costs and actual costs. 

    Variances between budgeted and actual costs can be investigated in order to determine the reason why actual performance has differed from what was planned.

  5. To motivate managers to perform well

    The budgeting system can influence the behaviour of managers and employees, and may motivate them to improve their performance if the target represented by the budget is set at an appropriate level.

  6. To evaluate performance

    Managerial performance is often evaluated by the extent to which budgetary targets for which individual managers are responsible have been achieved – responsibility accounting. 

    Managerial rewards such as bonuses or performance-related pay can also be linked to achievement of budgetary targets

The overall planning and control cycle is summarized in the diagram below:

The overall planning and control cycle

The planning and control cycle

  1. Set Mission

    This involves establishing the broad overall aims and goals of the organization – its mission may be both economic and social. Most organizations now prepare and publish their mission in a mission statement.  

    Mission statements often include the following information:

    • Purpose and aim(s) of the organization

    • The organization's primary stakeholders: clients/customers, shareholders, congregation, etc.

    • How the organization provides value to these stakeholders, for example by offering specific types of products and/or services

  2. Identify Objectives

    This requires the company to specify objectives towards which it is working.  The objectives chosen must be quantified and have a timescale attached to them. Objectives should be SMART

    • Specific

    • Measurable

    • Achievable

    • Relevant

    • Time limited

  3. Search for possible courses of action

    A series of specific strategies should be developed. Strategy is the course of action, including the specification of resources required, that the company will adopt to achieve its specific objective.  

    To formulate its strategies, the firm will consider the products it makes and the markets it serves. E.g. of strategies are

    • Developing new markets for existing products

    • Developing new products for existing markets

    • Developing new products for new markets

  4. Gathering data about alternatives and measuring pay-offs
  5. Select course of action

    Having made decisions, long-term plans based on those decisions are created.

  6. Implementation of short-term (operating) plans

    This stage shows the move from long-term planning to short-term plans – the annual budget. 

    The budget provides the link between the strategic plans and their implementation in management decisions.

  7. Monitor actual outcomes

    Detailed financial and other records of actual performance are compared with budget targets (variance analysis).

  8. Respond to divergences from plan

    This is the control process in budgeting, responding to divergences from plan either through budget modifications or through identifying new courses of action.

How budgetary systems fit within the performance hierarchy.

As discussed in point 6 above, budgets provide benchmarks against which to compare actual results.  Through variance analysis, then the company needs to develop corrective measures.  However, budgets need to be flexible in order to meet the changing needs of the business.

The Performance Hierarchy

The Performance Hierarchy

Strategic Planning

Senior management formulate long-term (e.g. 5 to 10 years) objectives and plans for an organization. Such plans include overall profitability, the profitability of different segments of the business, capital equipment needs and so on.

Tactical Planning

Senior management make medium-term, more detailed plans for the next year, for e.g. decide how the resources of the business should be employed, and to monitor how they are being and have been employed.

An example would be: - how many people should be employed next year?

Operational Planning

All managers are involved in making day-to-day decisions. 'Front-line' managers such as foremen or senior clerks have to ensure that specific tasks are planned and carried out properly within a factory or office.

Operational information is derived almost entirely from internal sources. It is prepared frequently and is highly detailed.  It is mainly quantitative.

If a manager achieves operational plans, it is more likely of meeting the tactical objectives and ultimately the strategic goals.

How are planning and control inter-related?

Control involves measuring actual results and comparing them against the original plan. Any deviation from plan requires control action to make the results conform with the plan.

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