Budgeting process or budgetary system is a critical thinking area of managerial decision making that management accountants needs to handle with care else, make grave mistake that may cost the business all it has ever worked for. Budgetary system talks about the steps that should be followed by managers to make a reasonably implementable budget.
It is admitted that staff are the most valuable asset of a company- though some people are disputing this fact on the ground that technology has made it possible for one man to run an effective business. My standard question to these set of people; compared to what business?
This article will be describing how budgets are set in a common language that will be understood by all. The functions and benefits of budget in a business cannot be argued by anyone. I encourage you to read the functions of budgeting before continuing with so that you will have insight into why most things are done the way are being done.
How to make budget
There are basically six steps to setting a budget that every accountants and managers must know and follow. This section will bring them to your notice
- 1. COMMUNICATION OF OBJECTIVES: companies objectives are contained in a business strategic plan as discussed in the article titled ‘decision making processes’. Though it is hard to set an objective for a company but is a necessary evil that every business must have to perform. Once that is done, the first step in the budgetary process is to communicate the objectives of the company to all that are concerned in accomplishing those objectives. Having understanding of mission statement and strategic management will help in this regard.
- 2. IDENTIFICATION OF THE COMPANY’S LIMITING FACTOR: this is sometimes referred to as principal budget factors. There is no company or business that does not have constraint in one way or the other. This fact must be identified and addressed in the budgetary control system if it is to be effective. Otherwise, why do we budget if resources were to be unlimited? Every effort must be made to gear the rest of the budgeting process to reflect the limiting factors in the budget.
- 3. PREPARATION OF FUNCTIONAL BUDGETS: functional budgets are departmental budgets prepared to guide the actions and operations of functional managers.
- 4. CHALLENGE AND CO-ORDINATION OF BUDGETS: you don’t expect top managers to accept whatever that the junior managers brings to them as budget. Certain aspects have to be defended by the preparer of such budget in order to avoid a situation where budgets will be padded just to suit the functional manager. Padding of budget is a situation where slacks are allowed in the budget. Managers may for instance understate sales or over state cost. Again, superior managers need to ensure that the functional budget is in line with the overall goal of the company by coordinating them all. The issue of business ethics needs to also be addressed here.
- 5. PREPARATION OF MASTER BUDGET: a master is comprehensive document that contains forecasted; statement of financial position (balance sheet), Comprehensive statement of income (profit and loss account), and statement of cash flow (cash flow statement). It can be said to be the pro-forma financial statements of an entity. It is the function of the management accountant to prepare this.
- 6. REVIEW THROUGH A LOOP SYSTEM: the only thing that is constant is change and management must realize this and make changes to the budget as the general economic condition that was prevailing at the time the budget was set changes. This is the control aspect of budgetary system that works with a loop system whereby feedback are gathered from a system and used to take corrective steps.
Three ways of using budget and accounting information
According to Hopwood (1976), budgets can be used in any of the following styles:
BUDGET CONSTRAINED STYLE: managers are forced to limit their spending within the ambit of the budget and would be punished when budgets are overspent. It does not matter whether your action(s) will benefit the company in the long run. This style of budgeting process has been criticised for the possible occurrence of any of the following: low morale of staff, increased job stress, manipulation of accounting information just to meet with budget, poor worker-manager relationship, etc. Though situation may demand that budgets be strictly adhered to but, care should be taken not to make it be counterproductive.
PROFIT CONSCIOUS STYLE: this is budgetary style where the focus is on whether your actions and activities are geared towards long-term profitability and overall improvement of the business as whole. If you can prove that your action will favour the company in the future, you will be rewarded rather than being punished.
This style of budgeting avoids the drawbacks of the constrained style of budgeting and gives a business greater chance of ensuring that managers actions are all targeting the overall goal of the company.
NON-ACCOUNTING STYLE: here, accounting and budgetary information plays little role in performance evaluation. Other non financial factors are used to appraise managers’ performance. Research and development team may be evaluated on the basis of the quality of research being carried out and the number of new discovery made and not the amount of profit made from the department.
It sounds good to use this approach in developing and designing budgetary system but in the long run, money will definitely become an issue. In practice, it is difficult to find a company that fully adopts this style of budgeting for her day-to-day activities.
Budgeting can be viewed from two other perspectives, top-down and bottom-up approach. These are just philosophies and arguments as to whether it is better to get managers involved or not. Just like the authoritarian and participatory approaches discussed earlier. It is just a change of name.
As you can see, budgeting is not all about crunching of figures, certain subjective aspects has to be seriously looked into and meaningful conclusion drawn to help the manager in making a better economic decisions. This is where the term flexible budget is derived from.
You may consider buying the books displayed below for further information on budgeting and budgetary systems.