Chapter 20: Budget Process and Administration

Budgeting Process and Benefits Budgeting plays a key role in ensuring that the activities of employees and departments align with the company’s overall goals. It involves planning future business actions and expressing them in the form of formal plans, usually covering shorter time frames like a month, quarter, or year. This process of budgetary control involves developing a budget, comparing actual results to budgeted amounts, taking corrective actions, and setting new objectives. Benefits of Budgeting: 1. Planning: Budgeting forces management to focus on future opportunities and potential threats to the organization. This forward-thinking aspect ensures that managers are not completely absorbed by the daily demands of operations and have time to strategically plan for the future. 2. Control: By comparing actual results with budgeted targets, management can benchmark the company's performance and take necessary corrective actions if discrepancies are found. This comparison helps detect problems early, enabling management to correct course. 3. Coordination: Budgets help align the actions of employees and departments toward a common organizational goal. This ensures that efforts across different areas are well-coordinated and in sync. 4. Communication: A written budget communicates management's plans clearly to employees, preventing confusion and miscommunication. It makes the goals of the organization transparent and actionable for the workforce. 5. Motivation: Budgets set performance targets that can motivate employees. Companies often provide incentives, such as bonuses, to employees who meet or exceed these budgeted goals, driving better performance. 6. Bonus Tie-In: For many companies, beating budget goals is tied to manager compensation, with bonuses often being a significant part of total managerial pay. This incentivizes managers to work toward achieving budgetary targets. Budgeting and Human Behavior: While budgeting is generally positive, it can lead to negative outcomes if not managed carefully: 1. Participatory Budgeting: Allowing employees to contribute to budgeting fosters ownership, but it can also encourage them to understate sales targets or overstate expenses to create a buffer (known as budgetary slack) for achieving targets more easily. 2. Unethical Behavior: The pressure to meet budget targets can lead to unethical behaviors, such as manipulating numbers or spending unnecessarily to ensure the budget isn’t reduced in the next period. Budgeting Methods: 1. Rolling Budgets: This involves continuously updating budgets by adding a new quarterly or monthly budget as time progresses, ensuring that a company always has a budget for the next 12 months or four quarters. 2. Zero-Based Budgeting: This approach requires managers to justify all expenses for each new budget period, rather than basing it on previous periods’ budgets. It helps in eliminating unnecessary expenditures by only budgeting for essential activities. Positive and Negative Outcomes of Budgeting: • • Positive: o Budgets provide clear goals for employees. o Written budgets help communicate plans effectively. o Rolling budgets allow continuous planning for the future. o Budgeting forces managers to focus on future planning. Negative: o Some employees might understate sales targets to create slack. o Employees might always spend the full budgeted amounts to avoid budget cuts in the future. These are the essentials of budgeting and its effects on management functions, employees, and the company’s overall financial performance.