Budgets and Budgetary Control: Benefits and Limitations
Budgeting is a basic feature of business that is used by any business or company in order to set up a company's future endeavors by engaging in financial planning. These budgets are prepared for main areas of any business including: purchases, sales, production, labor, debtors, creditors, and cash (Penning, 2009, p.363). Further, these budgets provide detailed plans of a business and its planned endeavors for foreseeable future, often planning for the next three, six, or twelve months. As any successful business cannot hope to remain so without a solid financial leg to stand on, the topic of budgets and budgetary control is simply one that cannot be avoided in the business world, and as such, many key areas and factors of budgeting and budgetary control must be understood in order to achieve success.
Key Areas and Factors of Successful Budgeting and Budgetary Control
In order to understand the factors needed for the creation and controlling of an effective budget, one must first understand the difference between a budget and budgetary control. To begin, a budget is a formal statement of the financial resources set aside for carrying out specific activities in a given period of time, which helps to coordinate the activities of the organization (FAO, 2010, pp.1). Contrarily, budgetary control is a control technique whereby the actual results are compared with the initial budget, ad any differences or variances are made the responsibility of key individuals who can either exercise control action or revise the original budgets entirely (FAO, 2010, pp.1). As seen by these initial definitions, it becomes clear that no matter how detailed or sophisticated a company or organization's budget might be, that budget is essentially useless unless upon its implementation, the results show proof of that budget's effectiveness. In essence, budgets must follow the example of the proverbial phrase, "the proof is in the pudding," showing an ability to move successfully and efficiently from paper to action.
Budgeting and budgetary control is one of the most important factors in the successful operation and longevity of a business. As budgeting and budgetary control involves specific steps and different focuses dependent upon the specific company or organization that employs them, it is essential to understand the key areas and factors involved in successful budgeting, as well as their distinctive benefits and limitations. With different types of businesses or organizations implementing different types of budgets while also addressing certain areas of budgeting that are essential despite the type of budget used, a firm grasp of the following areas is needed in order to succeed:
Organizations use forecasting methods in terms of budgeting to more easily determine possibly future outcomes in terms of finances for that business or organization (Bass, 2012, pp.1). The primary advantage of budget forecasting is that it provides the business with valuable information that the business can use to make decisions about the future of an organization. However, its main disadvantage is that budget forecasting is extremely limited in its ability to forecast 100% what will happen in terms of the financial market, which can leave a company reeling in the event of an unforeseen budgetary disaster.
Budget Strategy Plan:
A strategic budget is closely linked with an organization's strategy plan, in that a strategic budget manifest the annual operating plan of an organization by displaying categories in quantities (Bianca, 2010, pp.1). The main advantage of strategic budgeting is that is allows an organization to translate strategic plans into financially-backed action, allotting for specific resource use throughout the budget period. However, strategic budgets can also create problems, especially if the budget is applied in a manner that that demotivates employees due to more financial backing being placed into a specific department.
Budget policy is the laying out of the amount of money within an organization as well as noting how that money will be used (Revers, 2012, pp.1). The main advantage of this type of policy use within an organization is that its use provides a solid framework to determine where funding will be used. However, this type of policy limits companies and organizations in its inability to account for any problems that may occur along the way during the budget period which may need addressing, and under this policy system would have no available resources to utilize.
Budgetary accounting is a method of accounting in which the planned amounts and the actual amounts spent and received are both included in the accounts, so that one can see at any time how much of the planned amount remains (FTL, 2012, pp.1). The main advantage of this type of accounting it its ability to account for essentially every financial aspect of a company, but again leaves little room for the unaccounted for, which can lead to serious problems within a company's finances should an unforeseen problem arise.
A master budget is a summary of a company's plans that sets specific targets for sales, production, distribution and financing activities, and it represents a comprehensive expression of management's plans for the future (AFM, 2012, pp.1). Above all else, a master budget can give a company an idea of where it wants to go and exactly how to get there in terms of financing, which is perhaps its greatest advantage. However, a master budget is exceedingly time consuming and cannot often be effectively accomplished without a large company's resources such as staffing.
A continuous or rolling budget is a plan that is always available for a specified future period by adding a period (month, quarter or year) to the period that just ended. The main advantage of this type of budgeting is the resulting always-current financial forecast that is present within an organization that not only reflects a business' most recent results but also any changes that may occur due to the economy or unforeseen circumstances (Myers, 2001, pp.1). However, this type of budgeting poses a limitation in that for it to work, management must access and process information more quickly, which often requires increased staff or upgraded IT provisions.
Long-range planning or long-term budgeting is a system that goes beyond the usual budgeting for a shorter term such as 3 or 6 months and moves into the realm of budgeting for a longer period, i.e. 5 years. Such planning is advantageous in its ability to force a company to think long-term, working today to achieve successes for tomorrow. However, long-range planning often begins to lose credibility after a period of two years, during which time plans can simply become stagnant or outdated (Essortment, 2012, pp.1).
Capital budgeting is the process by which a business determines whether projects that involve investing in a long-term venture are worth pursuing (Investopedia, 2012, pp.1). This type of budget is advantageous in its ability to assess finances in terms of benchmarks that are set within the company utilizing this type of budgeting. However, such budgeting is limited in its ability to work for smaller businesses without significant financial backing and long-term investment prospects.
A cash budget is essentially one that reflects the facts: how much cash can a company or organization take in and where will it go? (Nayab, 2011, pp.1). Such budgets allow companies to determine whether or not cash balances remain sufficient enough to keep up with regular business obligations. However, cash budgets are limited in that they may cause serious distortions in the budget, as cash influxes do not equate profit. This can be confusing within a company and set off mismanagement of funds and poor overall budgeting and budgetary control.
An operating budget is the annual budget of an activity slated in terms of a "Budget Classification Code," indicating both money spend and money projected to come in (Morgan, 2012, pp.1). Such a budget is significantly advantageous in terms of a company's future investment prospects, as it sets aside funds for things such as policy maintenance and taxes. However, such budgets offer little flexibility, which again can hinder a company in the long-term.
Overall Benefits and Limitations of the Budgeting Process
Key factors of successful budgeting aside, budgets and budgetary control within an organization provide a wide range of benefits and limitations. Budgets, as known by many members of the business world, are considerably advantageous in terms of their ability to link company or organizational objectives with the resources available within that company or organization. For instance, in terms of a smaller company, a large project may not be feasible if certain financial backing does not already exist within a company. In this instance, budgetary control and budgeting itself allows a company to strategically plan where a limited amount of finances can be placed in order to reap a maximum award. In addition to setting budgets, employing budgetary control methods within a company can allow for that company to: define goals, define responsibilities, set a basis for performance evaluation, use resources…