The key role of budgetary control to organisations

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

Budgetary control is part of overall organization control and one of the most important tools used for planning, controlling and co-ordinating organizations. It is a tool to achieve financial control of organization and compare actual result for a defined period of time with the budgeted (flexed) results. Any differences are being investigated and corrective actions are taken to make sure that the actual activities do not deflect from the budgeted. Majority of world's most successful companies have attributed a large part of their success to reliance on traditional budget systems. Besides the financial control, budgets are also prepared for planning purposes as a part of the strategic planning process. It is quantitative plan of management's belief of what the business costs and revenues will be over a specific period of time. It is important to recognize that budgets do not exist in a vacuum; they are an integral part of planning framework that is adopted by well-run businesses (McLaney and Artill, 2002). Buckley and McKenna (1972) describe budgetary control as consisting of planning, controlling, co-ordinating and motivating through money values and departments within an organisation. It is a plan, in quantitative terms, usually for 1 year.

Budgetary control plays a key role in the organizations control. The main roles of budgetary control are: intend strategy operationalization (Anthony and Govindarajan, 2003, Merchant and Van der Stede, 2003, Hongren, et al, 2002, Simons, 2002) allowing assessment of the strategy and resource allocation(Mintzberg, 1983,Hansen and Van der Stede, 2004, Walker and Johnson, 1999, Merchant and Van der Stede, 2003, Hongren, et al, 2002) coordination and communication (Anthony and Govindarajan, 2003, Merchant and Van der Stede, 2003) learning and strategy creation (Simons, 1990, 2000, Shield and Young, 1993) performance evaluation (Mintzberg, 1983, Hongren, et al, 2002, Anthony and Govindarajan, 2003) and motivation ,mainly through reward system based on budgeting(Govindarajan and Gupta, 1985, Walker and Johnson, 1999, Mintzberg, 1983).These crucial roles of budgeting help managers to position their company in a better way in the market place and add value to their products and services. As a result of better position in a market place, it can attract new investor and increase market share because it is the financial plan for a future period of time. Most importantly budget is a plan, not a forecast. In the dynamic and changing business environment budgetary control admits that it has an internal crucial role on organization members and helps them to improve continuously. Externally, it recognizes the importance of shareholders on the business operations. In other words, it is not only important for top managers to plan future of the business but it can also help shareholders in many different ways to see overall view of business. It is necessary to see and understand the budgeting process as a guide to future action, rather than a rigid plan which must be followed regarding changing circumstances.

Nowadays, there are many uncertainties in the business environment, therefore managers and some of the stakeholders must be balanced and prepared to compete under these rapidly changing conditions. In order to survive and expand under environmental complexities and uncertainties managers and stakeholders of the organizations need tools/proven management techniques to predict the crucial changes which are more likely to affect the business while they choose future direction and dimension of resources needed to achieve selected goals. Budgetary control is a proven management tool (Chandler, 1990) which helps organization management, and enhances improved performance of any state of an economy in different ways. Budgetary control is more useful when done as an integral part of organisation's strategic analysis. It is also communicative because it suggests every single stakeholder in the organization what needs to be done in order to attain their selected goals. Communication is a crucial part of the budgeting process, since objectives must be clearly understood and accepted by all departments and functions. Budgeting therefore requires that the manager, who is in charge of the whole budget, and everyone else involved in the budgeting, i.e. in charge of parts of the budget, must discuss the budget jointly in order to arrive at the best result (Adedeji, 2004).

To remain competitive in the dynamic business environment, companies need to make sure that their budgetary planning and control systems converge with its strategies. When the top managers formulate the budgetary plans and allocate capital, they must consider some important issues which may have an impact on the company, i.e. which strategy/department has more benefits to company, how much of capital to invest, to decide on the employee/machinery ratio. Particularly they should consider shareholders because expectations of shareholders can influence organization and budgeting process. These kinds of issues become more important when investors constantly demand the delivery of shareholders value regardless of company's long-term plan for deploying human and financial capital. The expectations of shareholders influence the budgeting process and organizational control in many ways. The budgets importance for shareholders is the shareholders concern about firm's future profits and share price, since this information is important for shareholders while making their investment decisions. Different types of budgets provide variety of financial information to shareholders in order to help them easily predict future profits and share price of companies. In today's large organizations not only one person (boss) controls and manages the company, instead fund manager controls the organisation and this puts additional pressure on the companies to consider shareholders value. The changing emphasis of share ownership and management lead to more active and influential share-dealing environment with an emphasis on current year's dividends and earning as well as current share price rather than future performance. Creation and maximization of shareholder value is one of the most important tools for evaluating performance of the company. Creating shareholder value is an important factor in the investment decisions, since it differentiates the more successful companies from everyone, because it depends on the quality of budgetary planning and control systems. In other words, budgetary control is very useful tool to shareholder to become aware of overall picture of business.

If the company makes poor investment decisions, it will damage profits of company and share price will fall. Negative Net Present Value projects can put companies in a serious trouble and causing them to waste large amount of money. For example, Coca-Cola invested in pastes and wine but the rate of return was not at a desirable rate and lower than its costs of capital. Therefore, share price of Coca Cola has decreased considerably at that time. Companies should not only focus on sale maximisation but they must also consider their shareholder needs and share price because capital market always demands for increased rates of return and share prices. Master budgets can help shareholders because it is similar to profit and loss account but it is future estimates of costs, sales and revenues. Therefore, shareholders can predict the rate of return which they will receive by the end of their investment horizon. These kinds of assumptions can give a clue about rate of return on capital employed and dividend to shareholders. In addition, budgetary control includes financial results which are key measure of corporate performance. These key financial results help shareholders to make investment decisions basing their choice on financial results which are prerequisites for the future share price. As I mentioned in the introduction budgetary control is a process of taking budgeted figures for the future of business, flexing them and comparing flexed figures with actual results for finding out the discrepancies. The comparison allows shareholders to take corrective actions for their investment decisions at the appropriate time.

Capital market has a huge impact on budgets because company rely heavily on capital market. Companies always try to have good relationship with their shareholders. If the companies' budgets are reliable and realistic, they will attract new investors. Also, good relationship with shareholders will create opportunities to companies to position their company in a better place at market and further increase the share prices. Therefore, capital market can influence implementation and preparation of budgetary control in the competitive business environment. Giant corporations are affected by capital market pressures unless they deliver constant shareholder value. This constant pressure on the share price can effect and force changes in budgetary control system. Budgets can also provide a framework to shareholders for evaluating manager's performance in meeting individual and departmental goals. Take an appropriate action where there is deflexion from the budget and try to make necessary adjustments. Shareholders point of view, budgetary control can be a sharp tool to maximise its profit. In other word, doing everything properly will lead to increase profit and efficiency in organization.

To achieve its ambitious five year master plan, the Unilever Group states: "Our strategic objectives and the imperative for change are clear. To translate strategy in to action, we must align the entire company and all our employees behind our strategic aims". If the employees feel that top management does not believe in the budget, these employees are unlikely to be active participant in the budgetary process. Furthermore, if budget are unrealistic it can demotivate the employees because employees will know that they cannot achieve selected goals. This shows that it is an integrative and communicative management tool to evaluate organizations' performance. Setting the objectives can motivate managers and staff in their performance. Managers will be better motivated by being able to relate their particular role in the business to the overall objectives of business. Since budgets are directly derived from corporate objectives, budgeting makes this possible it has an impact on behaviour of people in the organizations to try maximise efficiency. Therefore, motivation is an important underlying factor in ensuring that achievable budgets are set and managers will have responsibility to achieve each element of budgeted plans. In addition, if company doesn't meet a planned performance, manager can use a flexible budget and variances. Because they help mangers gains insights into why the actual result different from planned performance. Furthermore, manager can use variances and flexible budgets to measure specific of type of performance goal such as continuous improvement. In view pint of shareholders, budgetary control can be a sharp tool to maximise its profit. In other word, doing everything in proper order will lead to increase profit.

The importance and role of budgetary control mentioned earlier have been widely recognized and, indeed, the vast majority of companies still use a budgetary control to evaluate performance. However, there is a critical issued in today's highly dynamic and competitive environment, budgets may actually have an adverse effect on the ability of business to compete effectively. Budgets fail to deal with most important drivers of shareholder value such as intangible assents like brands and knowledge. The main problem of the budget is that it is based on a lot of guesswork. In other word, shareholder cannot exactly know what will happen to share price in the near future but they can only guess or predict. In practise, budgeting can be a lengthy process that may involve much negation, reworking and updating. As a result of time spent on budgeting, it may have little contribution to achievement of business goals and shareholder value. Ole Johannessson, VP finance at Volvo Cars states: "The budget and long-range planning systems are no longer efficient when the business environment is changing more and more rapidly. Today we need a process that enables us to react not only immediate but even before hand". In some business managers' focus too much on achievement of short-term financial targets instead, managers should focus on the things that add value to business such as building brand loyalty, innovations and analyse your competitors in order to increase share price. Also, budgeting may not really help shareholders when they need to consider an effective investment decisions because most budgets provide only financial information and do not specify where and how it should be spent.

In conclusion, budgetary control helps shareholders in many ways such as making investment decisions, predictions and so on. However, there are clearly different views whether or not budget is an effective and essential business tool. Large numbers of successful and big companies still use budgets as a part of their strategic planning process. However, companies like Volvo, IKEA and Ericsson, have already considered annual budgets as being an inefficient tool in an increasingly changing business environment.