Behavioural Aspects Of Budgeting Exercise
Establishing a budget is an important activity that any individual or business must do. As a university student, I perform budgeting exercise quite often, for example, planning my monthly budget for rent, food, utilities, entertainment and also budgeting to plan for taking a trip to India after final exam. For a business or organization, budgeting exercises can be, for instances, budgeting for next year’s sales revenue, buying a manufacturing plant, purchasing raw materials, hiring the number of labour, and many other. These few examples show that budgeting is a step one may use for controlling routine operations, to plan for major expenditures, and to help with financing decisions. However, not many people are fond of this important exercise. There are strong opinions about budgeting activity and how it could have such a big impact on the people especially in an organizational setting. Therefore, the purpose of this assignment is to discuss both negative and positive behavioural aspects of budgeting exercise.
A budget is a plan that outlines an organization’s financial or operational goal. It is an action plan. It helps a business allocate resources, evaluate performance, and formulate plans. Understanding the importance of budgeting is the first step in successful financial planning. Budgeting is intended to carry out at least three broad functions (Wiersema, 2005).
• Planning. This is the most obvious purpose of a budget, which is to quantify a plan of action. Planning is concerned with, for example, specifying the type, quantity, and quality of services that will be provided to constituents such as estimating service costs, and determining how to pay for the services.
• Controlling and administering. This purpose of budget helps assure that resources are obtained and expended as planned. Managers use budgets to monitor resource flows and point to the need for operational adjustments. Legislative bodies, such as boards of trustees, use budgets to impose spending authority over executives such executive directors, who in turn use them to impose authority over their subordinates such as department heads.
• Reporting and evaluating. Budgets set the foundation for reports and evaluations at the end of the period. Budget-to-actual comparisons reveal whether revenue and spending mandates were carried out. More important, when tied to an organization’s objectives, budgets can facilitate assessments of efficiency and effectiveness.
A budget has an impact on practically all employees in an organization. There are three groups of people affected by it, which include the ones planning for the budget, the ones using it for decision making, and finally the ones whose performance is assessed using the budget (Smith et al, 2006). Budgeting is a key success factor for most businesses, yet almost everyone agrees it is a painful process that takes too much time and effort, especially for the people who prepare the budget. To them, budgeting is only as accurate as their ability to accurately predict the factors that will affect their companies in the future. Yet, on the other hand, many managers complain that they do not know how their businesses are doing. When the financial statements come at the end of the month, often time managers find unpleasant surprises. They feel out of control of their own destiny if, for example, there is a big variance between their budgeted and actual costs. The right information seems to be lacking. In addition, the law of diminishing returns may also work on the budgeting process. The never-ending, attritional nature of budgeting can seriously undermine support for, and the subsequent effectiveness and accuracy of the budgets produced. Thus many managers of businesses view budgeting as a waste of time.
Most employees also consider that companies are now putting too much emphasis on budgeting exercise, and only evaluating performance based on the target set by the management. Yet they fail to understand the importance of communication and involvement throughout the process. Most often, different perspectives between managerial levels may also occur. Senior people tend to underestimate, and junior people tend to overestimate. Therefore, in order to achieve all level acceptance of budget, companies should allow participation from all levels, for example, to develop their own initial estimates for budgeted sales revenue. Allowing participation in the budgeting process may promote coordination and communication between managers, which will create greater understanding and appreciation of the organisation as a whole. Furthermore, it will lead to more accurate budget estimates as those close to the operations have the best knowledge of the likely sales or costs in their area. Finally, it will also lead to individuals identifying more closely with the budget targets.
However, participation of more people from the budgeting process may result in inaccurate budgeting. With lack of support and control from managers, employees may lead to budgetary slack or padding the budget, in which subordinates intentionally underestimate revenue or overestimate expenses to make budget achievability easier. Employees may do this because they want their performance to look better if they can achieve the target. They also tend to do this for the reason of coping with uncertainty, and protecting from initial budget requests being cut back by management (Smith et al, 2006).
According to Smith et al (2006), there are a few things that an organization must consider when setting the budget so that it is accepted by all staff. Firstly, the targets must be developed with all employees’ participation. Secondly, the targets are considered achievable and there must be frequent feedback on performance. Thirdly, employees are to be held responsible for activities that are within their control. Lastly, achievement of targets is accompanied by rewards that are valued.
In conclusion, since budgets may affect many people in an organization, they can also have significant behavioural implications. Allowing people to participate in setting their own budget targets may improve commitment to those targets, but can also create the incentive to build budgetary slack into budget estimates. Budgeting, when applied in the right way, can give employees a new insight about their companies and the drivers of profitability.
Smith, K.L., Throne, H., Hilton, R.W. (2006), Management Accounting: information for managing and creating value, 4th edition, McGraw-Hill, Australia
Wiersema, W. H., (2005), “Why budgeting is essential for a business”. [available at http://findarticles.com/p/articles/mi_qa3726/is_200503/ai_n13244282], [viewed on 13 May 2008]