Question

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  How are budgets used for performance evaluation?

Financial budgets are normally prepared by the finance or accounting department of a company. In small businesses, the owner is required to prepare this budget. A performance budget allows businesses to plan for future expenditures. A budget, therefore, determines the amount of capital required to generate a certain level of sales. Businesses also adjust future expenses based on the past budget performance. Through analyzing and reviewing the budgets, a business will know the amount it has and identifies if external financing is required.

A budget helps businesses track its spending variances. Although financial budgets are prepared on annual basis, tracking of budget variances is done monthly (Vitez, 2018). This tracking enables businesses to understand where the funds were spent and compare with the number of revenues generated. Anny excessive budget variances will require businesses to review their budgets to make sure they are accurately forecasted.

Businesses use performance reports to provide additional information to the managers concerning the budget variances (Vitez, 2018). This information may be either financial or non-financial information which may impact the budget to exceed its allowable limits. Resource costs may cause the financial budgets to increase. Inferior resources are examples of non-financial budgets which may make the budget to increase.

Performance evaluation requires managers to have a benchmark for the past years will act as a guideline in future. This is normally communicated to managers through a budget for their responsibility center. At the end of the accounting year, each center is evaluated based on the actual sales generated. This information will only appear on the performance evaluation report.

Answer 1

Generally, the major source of income of business is Sales. Budgets are financial plans of the business which helps in allocations for revenue for the future. Apart from estimating future sales revenue, budget consist estimation of expenses such as payroll, rent, utilities, supplies, advertising, insurance and taxes. Budget contains the both categories i.e. Income and Expense. Budget also work as a baseline for a company’s future performance. After anticipating financial conditions and market expectations, managers create the budget for future periods. Budget can be static and flexible. It can be used to evaluate the number of units produced or services rendered, the labor hours and materials used. The process involves allocating resources to various compartments within the budget, then going back after the work is complete and comparing budgeted resources with actual usage. The original budget in which estimates are made is called a static budget. A flexible budget can be prepared adjusting the static budget to show actual results. Future budgets can be constructed using data from the flexible budget. For evaluating performance first we need to create a budget and then we can evaluate our performance after considering the actual result and caper variance between budget and actual and find out the major drivers of variances.

Creating a company budget involves every department within the organization. The sales department anticipates market conditions and estimates future revenues to create a sales budget. The production department uses this information to create a production budget anticipating material, labor and overhead costs. Administrative and selling managers anticipate their expenses for the upcoming year. A budget manager coordinates the communication between each department and compiles each section into a master budget and creates budgeted financial reports.

Measuring Actual Result: The accounting department records monthly transactions in the general ledger. The accountant creates regular financial statements to communicate the financial results for the company. The accountant also creates financial reports which communicate sales activity and department expenses for individual departments. The accountant distributes the department reports to the appropriate department managers and the complete set to the budget manager.

In evaluation of performances we use control process which involves three sequential but interrelated stages:

1. The recording of actual performance,

2. The comparison of actual performance with expected performance,

3.and as a linking stage the provision of regular feedback to allow continual monitoring of events.

1. Recording actual performance

We have seen that formulation of plans and budgets are carried out for different areas of activity within the organization. if such budgets are to be used assess and evaluate individual performance, managers need some criteria to determine exactly what constitute area of activity. To achieve this, budgets should reflect areas of responsibility within the firm so that individuals are charged only with those costs and revenues for which they can be held responsible. Responsibility centers are usually cost centers, profit centers or investment centers. The nature of the organizational structure will determine the types of responsibility center. Manager in charge of a cost center is held accountable only for the controllable costs of his or her center. In a profit center a manager is responsible for the profit, or contribution earned by his or her section of the business, the manager of an investment center is responsible for the return on assets under his or her control.

2. Comparison of actual and expected performance

For control purposes it is necessary to compare actual and budgeted costs at the level of activity achieved during the period. This ensures that valid comparisons and inferences can be made when the budgeted activity level is not attained. If the organization's output tends to vary across a range of levels, then several different, flexible budgets should be prepared. They show the effects on costs of producing at various activity levels, and thus put the management in a better position to evaluate performance and take appropriate action accordingly.

3. Provision of feedback information

Timely and regular feedback is necessary to a successful control system, as it is helpful for both managers and employees. For example, managers need speedy information on significant deviations from budget to take effective action to correct such deviations and to amend future plans; employees need equally speedy information to know whether or not they have achieved their targets, and whether their performance is satisfactory.

Adjusting future Entries: Management can use the evaluation results to determine if goals are being consistently met. If not, periodic budget reviews can provide the business with an opportunity to modify procedures or implement changes. In addition, needed modifications can be incorporated into the next set of budgets.