There are many benefits to budgeting that can help an organization. Budgeting encourages participation and increases communication between departments, managers, and employees. Through communicating quantitative numbers, a company can grow closer and this can help them reach goals quicker. Budgeting also helps companies see how they allocate the resources within the organization which can help them better understand where the money is going. It helps to monitor and to control operations. It forces organizations to look to the future instead of staying in the past. It requires all parties involved to see the internal and external affect each decision has on an organization and to think critically about future decisions. Most importantly, budgets can also be a warning sign to a company on when to take corrective action and to investigate abnormalities in the system.
There are also many disadvantages that come with budgeting. The time constructing the budget may be unreasonable by costing you money to make it because of the opportunity cost. Since most expenses are flexible, the accuracy can be wrong since these numbers are based on estimates. You may not be able to construct a budget without requiring confidential information and this can lead to some problems when trying to obtain these figures. Also there could be a tendency to spend according to your budget, therefore not making big risks or trying to alter the budget for the better. Budgets can also fail for a variety of reasons as well. The person in charge of the budget may not fully understand what a budget is or how it is used. Some organizations make unrealistic goals that no budget can accomplish. Companies need to make reasonable goals to follow. Another reason why budgets can fail is that the company might just give up too easily on it if theyâ€™re not seeing immediate results. Budgets can take a month to see a difference or even years, so patience is key when dealing with budgets.
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1. d) Budgets are a important tool for managers to achieve cost effective and efficient results. Budgets help managers to set clear goals or results desired and makes sure everyone involved understands what are the company goals. Managers can use budget to improve coordination and communication amongst departments. Also, budget allows managers to monitor progress against forecasted performance. Furthermore, budget gives managers and employees motivation to achieve actual measurable set of goals.
Budget gives managers clear understanding of what results or goals are expected from their departments or employees. In the planning stages it is important to allocate right amount of needed resources in a timely manner. This is achieved through coordination and communications between separate departments and employees.
Budgets are managements forecasted operating and financial performance, often using previous year's figures. Managers can compare actual current performance against forecasted budget to evaluate current performance of the company. But, it should be noted that the budget should not be the lone performance measurement as comparisons used in the budgeting process could be skewed. Also, budgets are useful for managers to collect data to improve future performance.
Important part of planning for budget is to set a reasonable but challenging goals for the company. When managers and employees are given budgeted set of goals need to be reached, it allows them to see clearly the goals needs to be achieved. Employees view budget numbers as a indicator for success or failure. Also, it is important to predict reasonable and achievable result, otherwise unreachable goal might discourage workers and might have negative effect on their morale
Companies use many different budgets. The budgets can either be simple or they can be complex, and each of them is analyzed differently. An example of a simple budget is a flexible budget. This budget utilizes the actual amount of product sold, the actual sales mix, but uses the budgeted contribution margin per unit. Another simple budget is a static budget which uses budgeted numbers for the amount to sell, product mix, and contribution margin per unit. There is another simple budget which doesnâ€™t have a formal name, but it takes the actual amount of units sold, and budgeted amounts of product mix and contribution margin per unit. These budgets are a bit easier to formulate and usually take historical data into account when preparing them.
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The more complex budgets use multiple steps when forming the initial budget. An example of this is zero based budgeting. Zero based budgeting, more commonly known as ZBB, is a technique that flows through the entire organization starting from the divisional manager, who is usually the zero base due to the fact that an increase or decrease in the budget will not affect them, and stemming through each department. Each department evaluates and analyzes the budget in a comprehensive manner, and if expenses are increased, it must be approved by each level of the organization. This benefits a company in many ways. It enhances communication between the departments involved and it puts more responsibility in the hands of someone who might not have had much responsibility therefore encouraging them at work. It also makes understanding the goals that are set and the way they are being handled to achieving these goals. It acts as a driving force for managers to mold their costs to further develop operations. It is also an easy way to quickly identify and eliminate unused or outdated operations, and recognizes opportunities when outsourcing can be utilized effectively. Like any budget, there are also negatives like that some departments donâ€™t have proper training on a managerial level. In the micro-management level, ZBB deals with trivial issues instead of focusing on the development and progress of the company. Another downside is that people are forced to evaluate the budget and therefore the demand this takes can be a drawback. ZBB is more extensively used in departments that have an easy identification of outputs. So some companies cannot use ZBB as effectively as it can use a different type of budget.
Another budget is the incremental budget which uses the previous year as a base and adds or deducts amounts appropriately for the current period. The benefits of incremental budgets are that they are steady and only change gradually. The changes are also visible so one can review it comprehensibly making it operation-friendly. This budget also helps the managerial level officials by conforming them to their own department making them more consistent. There are drawbacks of incremental budgeting as well however. Incremental budgeting assumes that activity will be stable and work the same way as last period. There is no incentive to develop new ideas or reduce costs. It stagnates the budget since it encourages spending to reach the budgeted amount. Managers may budget favorably by putting too much slack in the budget making it easier to work to. Also, the previous budget might need to be updated due to a new level of activity or of new resources obtained. Incremental budgets are easy in nature and therefore can be used inefficiently.
The last complex budget I will discuss is the Performance based budgeting, better known as PBB. This deals neither with information about program related performances nor decision making information about the distribution of resources. Instead, it is a process of assessing the o00performance of an organization as a whole. PBB comprises a plan that is set to meet a set of achievable performance marks at a given level. With these goals determined, the budget is passed along through different sectors and implemented appropriately. Prior to forming the budget, there are three elements that must be considered, these are having the ultimate outcome of performance, the strategy to use to reach the destined result, and the activities to be performed to achieve the set goal. Therefore, PBB is best when trying to attain a certain goal. Benefits of performance based budgeting is that it informs the public of expended amounts and the benefit associated with it. Letting the people know where all the numbers come from. PBB also permits a transparent view of the trade-offs between alternatives, giving the company beneficial ways to reallocate resources if needed. This budget will also improve performance and focus in the public sectors, prioritizing things that they see fit.
Variance analysis is an important tool for managers to evaluate how well they are budgeting compared to the actual results that they have incurred. The analyzing process gives management more information on to why the balances have come up favorable or unfavorable. Managers expect to get favorable results, but unfavorable results can help them change the way they budget and help improve the overall budgeting process in the long run. The variance is usually made up of two components which consist of either price or cost, and quantity involved. Variances generally deal with revenues and expenses. There are many different types of variances including multiple sales variances. There are also variances related to costs and even work wages.
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First type of variances involves sales. A level one variance would be the static-budget variance which is the difference between the actual result and the static budgeted amount. Level one just takes in account the actual results and the static budget. Then there are level two sales variances. One is the flexible-budget variance which is the difference between the actual result and the flexible budgeted amount. The second is the sales-volume variance which is the difference between the static budget and the flexible budget. These level two variances introduce the flexible budget which is compared to both the actual results and static budget. Budget variances go up to level three which introduce a new budget which uses the actual units sold, but the sales mix and contribution margin per unit are budgeted. The first variance of level three is the sales-mix variance which compares the new budget with the flexible budget. The emphasis is on a shift of selling more or less of higher or lower profitable products in a sales mix. Then there is the sales-quantity variance which measures the difference between the new budget and the static budget. This variance puts emphasis on the number of units sold. Obtaining information and analyzing the variances can be the difference between a gain and a loss from one period to the next.
Other types of variances include a revenue variance analysis, a cost of goods sold variance analysis, and a variable labor variance analysis. The revenue variance utilizes price and quantity and the variances are based on the difference between the budgeted and actual amounts. This makes up the price variance and volume variance which inclines makes up the price-volume variance. The cost of goods sold variance measures the difference between the actual and budgeted amounts of costs and the quantity. This will make up the cost variance and volume variance which in turn creates the cost-volume variance. The last major variance used is the variable labor variance. This variance involves the budgeted and actual rate of wages, but uses budgeted time, actual time, and actual time after overtime in hours. The difference between the rates is the rate variance. The difference between the budgeted time and actual time plus overtime is called the volume variance, and the difference between the actual time after overtime and actual time is described as the efficiency variance. The contrast between the efficiency variance and the rate variance is called the rate-time variance. If management can budget appropriately, they should see favorable balances more so than not.
2. During the 1970's Florida company called Florida Power and Light Company successfully implemented zero-based budgeting. Compared to regular budgeting process, zero dollar budget starts with zero budget and when needed every expenditure needs to be justified each time. In this budgeting system everything is evaluated individually for best possible cost or efficiency. Drawback of this system is it takes considerable amount of time for managers to justify or review each proposed expense or project. However if properly implemented, it saves costs by making managers to find best possible cost or method.
During 2012, Apple Inc. spent $3.4 billion on research and development, significant increase, up $952 million, or 39% from last year. Even though, research and development budget went up last several years it represents only fraction of its total sales. Research and development budget was only 2% in 2011 as well as 2012. Rivals of Apple budgets more on research and development, Microsoft spent $9.8 billion in 2012 and Google spent $5.2 billion in 2011. Apple believes in timely released products and enhanced products are important for its future rather than budget more funds for developments.
In order to have a system that is more adaptable to changes some companies changed to new modern budgeting method of Beyond Budgeting. Such as, Svenska Handelsbanken, a Swedish bank, who is one of the more successful companies using Beyond Budgeting method. Some companies felt traditional budgeting process is outdated as far as adapting to changes. Beyond Budgeting gives managers more responsibility and accountability to rapidly changing events. This method allows managers to make quick changes to maximize performance and profit.
Government entities and charitable institutions usually use static budgeting. Static budget is effective for companies or entities that have fixed expenses and that fixed expense is pretty consistent throughout the year. Static budgets are simple. less time consuming and easy to prepare. Also, it allows departments, managers and employees to have clear set of budget to work with. Everyone knows ahead of time how much is budgeted for certain expenses or project and during the year how much left for that expense or project. Downside to static budgeting is when there are emergencies or new task comes up that was not included in the budgeting. Static budgeting does not have flexibility to deal with economy, personnel, emergency or competition changes. Therefore, it is important not to use static budgeting with a company has considerable variable expenses.
In conclusion, budgets are a planning tool for companies and individuals to determine future organizational goals and financial goals. There are fixed and variable types of expenses to manage when planning for budget. Also, there are simple and complex budgets depending on the type and or size of the organizations. Well managed and well thought out budget plan makes it easier for organizations and individuals to be successful. Organizational goals made during budgeting process can improve communications between different departments, managers , employees and help improve efficiency and effectiveness. It is also important to make a workable and reachable budget plan, otherwise the budget plan can have a negative impact. When budgets are unreasonable it can discourage companies and individuals to abandon the budget plan completely. Budgeting is an important part of running effective and efficient household or a business. Simple household budget consists balancing income and various fixed and variable expenses. But for a business budgeting there are more to it than just balancing income and expenses. Businesses use budgeting to plan organizational goals as well as gauge its performance. All businesses and individuals need correct budgeting to be successful.