MOD003319 Business Finance Anglia Ruskin University

Traditional approach of budgeting and appropriateness of traditional approach is evaluated in this context. This is the process which helps to analyse the main and essential aspect in terms of managing budget for future events(Cole and Sokolyk, 2016). Alternative budgetary methods are also discussed and evaluated in this context.

PART 1

1. Purpose of preparing budget and process of budgetary

It will enable you to concentrate resources on improving profits, reducing costs and increasing returns on investment. Once your business is operational, it's essential to plan and tightly manage its financial performance. Structured planning can make all the difference to the growth of your business. Converting this into a cohesive process to manage your business' development doesn't have to be difficult or time-consuming. The most important thing is that plans are made, they are dynamic and are communicated to everyone involved. See the page in this guide on what to include in your annual plan. The main aim of your annual business plan is to set out the strategy and action plan for your business. This should include a clear financial picture of where you stand- and expect to stand - over the coming year. New small business owners may run their businesses in a relaxed way and may not see the need to budget.

However, if you are planning for your business' future, you will need to fund your plans. Budgeting is the most effective way to control your cashflow, allowing you to invest in new opportunities at the appropriate time. The budget committee’s work is not necessarily complete once the budget document is prepared and approved. A remaining responsibility for many committees is to continually monitor progress against the budget and potentially recommend mid-course corrections.

Budgeting process

Budget serves a great guide by which a business can oversee its income stream and can identify potential dangers to it beforehand. Budgeting process is very crucial for any business entity. Without a proper budget, a business can never keep track of how much it has earned and how much it has spent. It serves as a monitoring and controlling method in order to manage the finances of a business. It begins by deciding upon the financial goals according to which the budget will be made (Dahmen and Rodríguez, 2014). Other important activities in the budgeting process include things such as forecasting, monitoring, controlling and evaluating the financial goals. There are basically two approaches are made in respect of making budgets;

Top down budget

Some entities will follow to downbudget approach to budgeting. These budgets will begin with upper-level management establishing parameters under which the budget is to be prepared. These parameters can be general or specific. They can cover sales goals, expenditure levels, guidelines for compensation, and more. Lower-level personnel have very little input in setting the overall goals of the organization. The upper-level executives call the shots, and lower-level units are essentially reduced to doing the basic budget calculations consistent with directives. Mid-level executives may unite the budget process by refining the leadership directives as the budget information is passed down through the organization (Hope and Fraser, 2013)

Bottom up budget

The bottom up budget approach is driven by involving lower-level employees in the budget development process. These individual budgets are then grouped and regrouped to form a divisional budget with mid-level executives adding their input along the way. Top management may initiate the budget process with general budget guidelines, but it is the lower-level units that drive the development of budgets for their units.

Eventually top management and the budget committee will receive the overall plan. As one might suspect, the budget committee must then review the budget components for consistency and coordination. This may require several iterations of passing the budget back down the ladder for revision by lower units. Ultimately, a final budget is reached.

Furthermore, the budget is prepared by those who have the best knowledge of their own specific areas of operation. This should allow for a more accurate budget. The participative budget approach is viewed as self-imposed. As a result, it is argued that it improves employee morale and job satisfaction. It fosters the “team-based” management philosophy that has proven to be very effective for modern organizations.

This occurs because of the repetitious process needed for its development and coordination. Another potential shortcoming has to do with the fact that some managers may try to “pad” their budget, giving them more room for mistakes and inefficiency. On the negative side, a bottom-up approach is generally more time-consuming and expensive to develop and administer

2. Application of traditional budgeting approach to plan costing and cost management

Traditional is a method of preparation of the budget in which last year’s budget is taken as the base. Current year’s budget is prepared by making changes to previous year’s budget by adjusting the expenses based on the inflation rate, consumer demand, market situation, etc. Past year’s revenues and costs form an integral part of current year’s budget. Only those items in traditional budgets need to be justified which are over and above the last year’s budget (Aminbakhsh, Gunduz and Sonmez, 2013).

3. Effectiveness of traditional approach to all parts of the business future form

ADVANTAGES OF TRADETIONAL BUDGETING

1. Historically it has been argued that budgets can be used to identify considerable savings in overheads and costs. This may be true, but what is important is that the budgetary control system keeps the organisation fit, monitors its progress and provides an important database in the decision-making-process.
2. A basis for performance evaluation is provided by budgets. They are an integral part of control and review procedure in that they establish agreed targets to be achieved, and for performance to be monitored against. This is why participation in budgets is so vital, since operations managers are effectively being asked to achieve an agreed objective within agreed parameters (Silva and Jayamaha, 2012).
3. Budgets promote essential principles of communication and coordination. This may be seen as applying the obvious, but the formal procedure will make the sales function talk to the operations and/or customer service function.
4. As an essential part of the management process budgets compel planning, making people within an organisation think about the future. A formal budgeting procedure with specified deadlines compels operations managers to divert their attention away from day-to-day business and get down to completing the budget.

DISADVANTAGES OF TRADITIONAL BUDGETING

After looking at the advantages, let us see some disadvantages of Traditional Budgeting:

NO PRIORITY FOR ALLOCATION OF RESOURCES

In traditional budgeting, the resource allocation depends on past levels. It does not take into priority any project which should be ranked higher according to their importance to the survival of the organization. This affects the profitability of business.

LESSER MOTIVATION

Traditional budgets are prepared by the top management by making few changes in last year’s budget. Therefore, it promotes bureaucracy. So other people in the organization feel ignored or unimportant. This acts against the motivation of the employees of the organization.

FIXED AND RIGID

Traditional budgets are fixed and inflexible. Once prepared, traditional budgets cannot be changed. Many factors like a new competitor in the market, change in policy, change in market conditions, etc. may take place, yet the budget stays the same.

EXCESSIVE RELIANCE

Traditional budgets put excessive reliance on past year budgets, which can prove fatal at times. If the past budgets are prepared with inaccuracy, the same would be carried forward to current year’s budget and years to come. This would lead to the preparation of incorrect budgets of the organization, which can harm the growth of the company in the long run.

DELIBERATE INFLATION

Managers may deliberately increase their budgeting cost and request the top management to allot them the increased cost without justifying such expense (Pietrzak, 2013).

PART 2

4. Alternative budgeting methods

ZERO BASED BUDGET

While this is good in theory, zero-based budgeting can become very time-consuming and expensive to implement. In business, the opportunity for gross inefficiency is kept in check by market forces, and there may not be sufficient savings to offset the cost of a serious zero-based budgeting exercise. Nevertheless, business managers should be familiar with zero-based budgeting concepts as one tool to identify and weed out budgetary slack. There is nothing to suggest that every unit must engage in zero-based budgeting every year. Instead, a rolling schedule that thoroughly re-examines each unit once every few years may provide a cost-effective alternative (Schulze, Seuring and Ewering, 2012).

With Zero based budget each expenditure item must be justified for the new budget period. No expenditure is presumed to be acceptable simply because it is reflective of the status quo. This approach may have its genesis in governmental units that struggle to control costs. Governmental units usually do not face a market test; they rarely fail to exist if they do not perform with optimum efficiency. Instead, governmental entities tend to sustain their existence by passing along costs in the form of mandatory taxes and fees. This gives rise to considerable frustration in trying to control spending. Some governmental leaders push for zero-based budgeting concepts in an attempt to filter necessary services from those that simply evolve under the incremental budgeting process. Business entities may also utilize zero-based budgeting concepts to re-examine every expenditure during each budget cycle.

ACTIVITY BASED BUDGET

ABB 'empowers' greater local planning and accountability and creates incentives for units to more efficiently manage resources and expenditures. Further, direct control of resources generated from activities creates incentives to set priorities and develop new activities consistent with the overall mission and strategic goals of the institution.

Activity Based Budgeting (ABB) is a method of budgeting designed to provide greater transparency into the budget process. In its most basic form, ABB is a method of budgeting in which revenues generated from instructional and research activities are allocated directly to the unit responsible for the activity (Miller, 2018).

ACTIVITY BASED BUDGETING Vs. ZERO BASED

Following points highlight the points of difference between Zero based budgeting and activity-based budgeting.

BASIS FOR BUDGET PREPARATION

Zero-based budgets are prepared right from the beginning, without considering last year’s budget. This method of budgeting allocates resources based on needs and costs of the department. On the other hand, it also do not consider last year’s budget, but the resources are allocated based on the efficiencies in business operations.

LINK TO BUSINESS OBJECTIVES

In zero-based budgeting, revaluation of the programs is done. That becomes the base for resource allocation. On the other hand, activity-based budgeting allocates resources after recording the relationship of business functions with the business objectives (Grigg and Votaw, Bank of America Corp, 2012).

RESOURCE ALLOCATION

In zero-based budgeting, the ranking of activities of the business is on the basis of their vitality. Only after the expenses incurred are justified, resources allocation happens towards an activity. On the other hand, in the case of activity-based budgeting, after justifying the cost drives the departments allocate the resources.

WASTEFUL EXPENSES

In activity-based budgeting, each function of the business is analysed keeping in view the functions and goals of business. It eliminates those functions that do not go well with any other function. Hence, it leads to further cost saving. Zero-based budgeting reconsiders all the activities of the business every year and allocates money only to those activities which justify the expense. Hence, eliminating the unnecessary activities results in cost saving.

5. Potential application of alternative methods of budget

Application of Zero Based Budget

This type of budgeting usually occurs in the government and non-profit sectors. The philosophy behind Zero Based Budgeting is good. However, it should be noted that zero based budgeting requires frequent reviews. In Zero Based Budgeting reviews are carried every year on account of the fact that it is a time-consuming and costly process. Interim reviews can be carried out but that is the organization’s choice with respect to time and priority.

Application of Activity based Budget

The implementation of modern managerial accounting systems has its benefits but needs certain facilities to be made available. ABB in two shared service departments (Accounts and Transportation) in two different companies. In addition, a simple survey of the two companies’ employees was adopted to acquire their reaction and feedback about the proposed budgeting system. Results show that benefits can be gained and difficulties resulting from lack of IT support can be overcome but with considerable human effort. When labour force is not a constraint, this provides the solution Availability of right cost information is of strategic importance, in terms of allocation of resources and the fees that should be charged to the customers. ABC can be used to estimate the costs of activities and, thereby, facilitate the budgeting process.

6. Analyse the appropriate method for the organisation in terms of enhancing effectivity

This financial management approach requires much documentation and justification. The persons ultimately responsible (high-level managers) can make decisions about investments and budget cuts that can be justified at all times based on their supporting information and no immediate pre-financing as is the case in the traditional manner of budgeting. In addition to the total budget, the manager responsible must identify all expected expenditures and rank all of the activities according to their relevant importance and costs (Moynihan, 2006).

Activity Based Budgeting (ABB) is a system that could be useful in managing shared service departments by providing deeper insights to their capacity utilization and resource allocation than a traditional budgeting system. This paper studies the possibilities, benefits, and difficulties that may face the implementation of an ABB system in an environment that lacks sophisticated IT based accounting information system. This study used an application experiment to implement the However, measuring human labour’s capacity is a factor that needs more consideration from accounting researchers.

Conclusion

Budgetary process and the essential aspects are defined in this context. Implication of budgeting method and evaluation done subject to managing operations of business. Importance of budgeting in terms of building the model of business also defined in this context. Alternative budgeting methods are discussed in terms of evaluating the effectiveness and appropriateness within business context. Potential application of traditional methods is also evaluated in this context. Comparisons of all the alternative methods are also discussed in this context.

References

• Cole, R. and Sokolyk, T., 2016. Who needs credit and who gets credit? Evidence from the surveys of small business finances.Journal of Financial Stability. 24. pp.40-60.
• Dahmen, P. and Rodríguez, E., 2014. Financial literacy and the success of small businesses: An observation from a small business development center.Numeracy. 7(1). p.3.
• Hope, J. and Fraser, R., 2013. the Budget.Budgetierung im Umbruch?.1. p.71.
• Aminbakhsh, S., Gunduz, M. and Sonmez, R., 2013. Safety risk assessment using analytic hierarchy process (AHP) during planning and budgeting of construction projects.Journal of safety research. 46. pp.99-105.
• Silva, L.M.D. and Jayamaha, A., 2012. Budgetary process and organizational performance of apparel industry in Sri Lanka.Journal of emerging trends in economics and management sciences. 3(4). p.354.
• Pietrzak, Å»., 2013. Traditional versus activity-based budgeting in non-manufacturing companies.Social Sciences. 82(4). pp.26-37.
• Schulze, M., Seuring, S. and Ewering, C., 2012. Applying activity-based costing in a supply chain environment.International Journal of Production Economics. 135(2). pp.716-725.
• Miller, G., 2018.Performance based budgeting. Routledge.
• Grigg, D.M. and Votaw, E.S., Bank of America Corp, 2012.Systems and methods for providing position-based budgeting information. U.S. Patent Application 13/018,238.
• Moynihan, D.P., 2006. Managing for results in state government: Evaluating a decade of reform.Public Administration Review,66(1), pp.77-89.

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