MOD003319 Business Finance : Budgetary and Management Control Process

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Answer:

Introduction:

Budgeting is very important process for proper functioning of an organisation. Budgets involve financial planning regarding resource allocation in various activities of business which allows systematic flow of those activities in order to achieve the organisational goal (Clowes & Scriven 2015). The traditional or incremental budgeting has been widely used in almost all types of business. But due to significant changes in business environment in modern scenario and rise in competition the traditional budgeting process do not seems to be of much use. A need arises to develop alternatives approaches to traditional budgeting like activity- based budgeting, zero- based budgeting, rolling forecasts to overcome the drawbacks of traditional budgeting.

Benefits of Budget:

• Budgets are the basic tool for planning the activities of business. Plans without budgets are difficult to execute. It promotes growth as it is always designed to ensure better performance of current year than previous years. Further with help of budget a firm can plan for future growth of organisation by ensuring that it has sufficient capital and resources in hand whenever required to make decisions regarding expansion of business (Vitez 2017).
• Budgets also help in coordinating the actions of various departments. It discloses in advance the target for each department, i.e., target sales units to sales department, estimated production units to production department to meet the sales and desirable finished goods requirement. Likewise estimated units to be purchased are assigned to purchase department accordingly to fulfil the requirement of production department. This coordination is very necessary for proper functioning and resources allocation in an organisation. For example, it may result in over or under purchasing of materials by purchase department then what was required which will result in wastage of materials or risk of shortage in materials, which will ultimately affect the production process and will further affect the sales target. It facilitates proper communication at each level or organisation and among each department regarding their authority and responsibility. This ensures that organisation is working systematically and decorously. This makes management to let the flow of work go according to budgets and focus their attention more on planning for future growth and development of business (Dima 2013).
• Controlling ensures that activities are performing as per plan which are designed for development of organisation. The standards determined in budgets are compared with actual performance and the reasons for any adverse deviations are identified to take corrective actions. It helps in evaluating the performance of each department and responsibility centre and company as a whole in terms of efficiency and effectiveness. In case of major deviations either reasonable steps are taken to make the performance according to plan, or the budgets are revised to make it more realistic (Peavler 2016).
• If incentive or bonus plans are linked to budgets, it acts as a motivating factor for each employees and managers at all level as it encourages everyone to perform better than the targets mentioned in budgets. This proves beneficial for not only employees but to the whole organisation.
• Budgets are mainly designed so that a systematic planning of available resources can be done, that is, how much amount will be required for each activity. This is very necessary in order to check any wastage or pilferage during any process. This helps in efficient and effective utilisation of resources and the saved resources can be used for expansion and development opportunities (Bamber & Parry 2014).  
• The rising competition in market do not allows a firm to raise sales price above a certain limit to earn more profits. Thus profit can be maximised only by minimising the costs which is possible only by preparing and adhering to various costs budgets, designed to ensure earning desired profit. Without budgets it becomes difficult to control costs (BIFA n.d.).

Traditional Budgeting Approach in ABC Ltd:  

Advantages and Disadvantages of Traditional Budgeting:

It assumes that business working and activities will be carried out in same way as in past year thus it fails to encourage creative approach to working methods and development of new ideas or innovation. These budgets are less flexible and rigid in nature. There are so many internal and external factors which may change during a year like economic and market condition, laws and regulations, emergence of new entrants with new technology, ideas, concepts, change in competition level and changes in business conditions internally. A traditional budget fails to take into account such factors and becomes useless for efficient business operations (Pidgeon 2010).

Traditional budgeting involves just adding the percentage to previous budgets which always assumes that all costs will increase in order to increase output. The problem with this approach is that first of all, it may happen that there were some inefficiencies and wastage in past activities that resulted in higher costs, adding percentages to same amount means that no steps are taken to reduce wastage and same inefficiencies are reflected in new budget. Another issue is that not every cost has direct relationship with level of output. Some indirect costs or support activities do not change with the change in output level and if changes they do not represent any clearly defined relationship with units produced. Estimates of resource consumption for such cost on the basis of input- output relationship will only give freedom and authorisation to authority concern to spend more till budget allows (Drury 2008).

Alternatives to Traditional Budgeting:

Zero- based budgeting: 

Activity- based budgeting: 

Overhead costs can occur as a large part for total operating costs; this method of budgeting strives toward taking measures to reduce such costs by encouraging better management and understanding of drivers of costs. By reducing the costs related to unnecessary activities, this budgeting provides a competitive advantage to a firm (CGMA 2013). This budgeting system treats business as a single unit and not as combination of various departments and is prepared considering the requirements of organisation as whole. But this budgeting is quite complex and requires deep research and understanding of various factors and functional areas affecting the business. This makes this approach costly and time taking, requires lot of expertise and involvement of top level managers.

Rolling budgeting:

One of the effective alternatives to traditional budgeting is rolling forecast which involves estimation partly on the basis of past performance and rest on the basis of changing market conditions and internal/ external factors affecting business (Lynn & Madison 2004). This method provides flexibility to budgets as a projection is made for a certain time horizon, which keeps on rolling (Hope & Fraser 2003). As a part for that particular period expires, say a month or quarter and next projections are made on continuous basis according to the financial and operational performance of organization and market situation. Rolling budgets are considered as more realistic and accurate than any other budget as it updated on regular basis as changes occurs in business environment. It saves time and resources as it requires only minor changes to previous budgets. But this method has limitation on ground that continuous change in budget may distract the managers and employees who were working toward the achievement of fixed target and can create confusion in organisation which might adversely affect their performance (Kapalan Financial Knowledge Bank 2012). It is advisable to only those businesses which are exposed to constantly changing environment with extremely varying factors otherwise it will only waste time and resources.

Application of Budgeting Methods to ABC Ltd.:

Application of ABB to ABC Ltd.:

Conclusion:

The kind of work performed by ABC Lt. involves some variations each year according to the nature of projects and contracts. The existing system of incremental budgeting is not appropriate for such business. Zero- based budgeting can prove to be quite costlier thus most appropriate one should be the Activity based budgeting along with feature of rolling forecast which enables it to revise the budgeting process according to change in circumstances. As company is also planning to re- structure its operation, the ABB approach will provide fresh estimation of activities actually required in operation in more realistic way.

References:

Bamber, M. & Parry, S., 2014, Accounting and Finance for Managers: A Decision- Making Approach, Kogan Page Publishers, London.

Clowes, R. & Scriven, V., 2015, Budgeting: a practical approach, 2^nd edn., Pearson Higher Education AU, China.

CMI, 2013, A selection of useful resources: Setting budgets with management direct, viewed 14 July 2017, from https://www.managers.org.uk/~/media/Files/PDF/CMI%20ManagementDirect%20-%20Budgets.pdf

Hope, J. & Fraser, R., 2003, Who needs budget?, viewed 13 July 2017, from https://hbr.org/2003/02/who-needs-budgets

John, A. O. & Ngoasong, L.N., 2008, Budgetary and management control process in a manufacturing: case of Guinness Nigerian Plc., viewed 13 July 2017, from https://www.diva-portal.org/smash/get/diva2:121487/fulltext01

Peavler, R., 2016, 3 reasons for business budget: Planning, control and performance evaluation, viewed 12 July 2017. From https://www.thebalance.com/business-budget-planning-reasons-393029

Pidgeon, C., 2010, Methods of Budgeting, viewed 15 July 2017, from https://www.niassembly.gov.uk/globalassets/Documents/RaISe/Publications/2010/Finance-Personnel/0610.pdf