Question

Discuss the role of budgets in overall organization plans. Discuss the importance of people in the budgeting process.

Answer 1

Role of Budget in Organisational Plans:

Budgets can be called upon to play a variety of roles. We shall discuss five of these. Three are major roles: planning, motivation, and evaluation; two are minor: coordination and education.

Planning—Operational budgets are plans; they provide details of what management hopes to accomplish and how. Their value in the planning process comes from the fact that budgeting forces management to examine in detail both the general economic situation of which the company is a part and the economic interrelationships among all the company’s various activities. Budgeting allows managers to explore how costs and revenues will behave under specific sets of operating assumptions.

The process often points out conflicts between top management’s objectives and the realities of the company’s capabilities. Through budgeting, management can both identify resources that will be necessary to achieve objectives and learn how those resources must be applied. If present resources cannot meet planned objectives, the process of operational budgeting may bring about an examination of the financial implications of additional asset procurement (capital budgeting).

Importance of people in the budgeting process:

Planning orientation. The process of creating a budget takes management away from its short-term, day-to-day management of the business and forces it to think longer-term. This is the chief goal of budgeting, even if management does not succeed in meeting its goals as outlined in the budget - at least it is thinking about the company's competitive and financial position and how to improve it.

Profitability review. It is easy to lose sight of where a company is making most of its money, during the scramble of day-to-day management. A properly structured budget points out what aspects of the business produce money and which ones use it, which forces management to consider whether it should drop some parts of the business or expand in others.

Assumptions review. The budgeting process forces management to think about why the company is in business, as well as its key assumptions about its business environment. A periodic re-evaluation of these issues may result in altered assumptions, which may in turn alter the way in which management decides to operate the business.

Performance evaluations. You can work with employees to set up their goals for a budgeting period, and possibly also tie bonuses or other incentives to how they perform. You can then create budget versus actual reports to give employees feedback regarding how they are progressing toward their goals. This approach is most common with financial goals, though operational goals (such as reducing the product rework rate) can also be added to the budget for performance appraisal purposes. This system of evaluation is called responsibility accounting.

Planning orientation. The process of creating a budget takes management away from its short-term, day-to-day management of the business and forces it to think longer-term. This is the chief goal of budgeting, even if management does not succeed in meeting its goals as outlined in the budget - at least it is thinking about the company's competitive and financial position and how to improve it.

Profitability review. It is easy to lose sight of where a company is making most of its money, during the scramble of day-to-day management. A properly structured budget points out what aspects of the business produce money and which ones use it, which forces management to consider whether it should drop some parts of the business or expand in others.

Assumptions review. The budgeting process forces management to think about why the company is in business, as well as its key assumptions about its business environment. A periodic re-evaluation of these issues may result in altered assumptions, which may in turn alter the way in which management decides to operate the business.

Performance evaluations. You can work with employees to set up their goals for a budgeting period, and possibly also tie bonuses or other incentives to how they perform. You can then create budget versus actual reports to give employees feedback regarding how they are progressing toward their goals. This approach is most common with financial goals, though operational goals (such as reducing the product rework rate) can also be added to the budget for performance appraisal purposes. This system of evaluation is called responsibility accounting.