Budgeting in its general sense is the act of quantifying objectives in financial terms. Budgeting assists managers in decision making process in an organization. It is the function of the management accountant to provide information needed in budgeting process. A management accountant must be happy with the functions of budgeting described here.
This article will explore the functions of budgeting in a modern and forward looking business in a simple and non technical manner. So, if you are non technical manager, relax and enjoy this article on functions of budgeting and if on the other hand you are a technical manager, still enjoy as you will gain new insight into the whole process of budgeting.
Broadly speaking, budgeting performs the following functions in a company:
Quantification of plans
Help in financial planning
Monitoring and controlling scarce resources through performance measurement
The above three functions gives a general overview of what budgeting is all about. It does not matter whether you are in business or not. These broad three functions of budgeting can be further subdivided into the following more specific functions of budgeting to give a clearer understanding in a more vivid and lucid manner.
7 FUNCTIONS OF BUDGET
FORECASTING: this entails making at calculated attempt into knowing what the future holds. Forecasting may not be perfect as evidence has shown but it is better to have a forecast to work with than not having any as this will help you get prepared. There are many statistical tools developed over the years to help managers and accountants make better forecast.
Forecasting is a complex exercise that requires you to consider many variables in the light of; the action of competitors, government actions, economic outlook, relationship between price and demands, etc. This article will not delve into that but you can buy this Amazon book to get more insight on forecasting.
PLANNING: generally speaking, planning depends on forecast that has been made in the past to make decision about the future. The estimated data generated by forecasting are used to make plans. Government agencies, for example health authorities use forecast from estimated population to plan on the number of health centers to open in a community and the number of beds and other health equipment that will be put in that hospital.
Business also use forecast figure to estimate the use of materials and make plans to ensure that they are provided as and when due. The list can go on and on….
Financial models on computers makes the mixture of variables on an ‘what if’ scenario possible so that the best possible mix of variables are achieved. Spreadsheet is one of the most popular financial models to use for planning and forecasting.
COMMUNICATION: budgeting in an organization acts as a communication tool in the following ways:
- 1. Gathering information: information about a company and the activities of its competitors are gathered during the process of making all kinds of budget. It is quite impossible for a single individual to gather all these information that are needed to make a functional budget. Managers and other non managerial staff will need to be consulted and information obtained from them. This information will then be analyzed, challenged and criticised in order to come up with filtered information.
- 2. Disseminating information: budgets when not acted upon are useless, so, the budgetary system has an inbuilt information dissemination ability that ensures that responsible managers actually got the budget which they will work with.
Budgeting committee is usually formed to act as a forum where representatives from different parts of the business will assemble to iron out issues that relates to resource planning of the business.
MOTIVATION: motivation is the driving force that makes people to run towards their goals rather than trudge towards it. Motivation is a relative and subjective term, we are not here to discuss motivation but, to see how budgeting affects the motivation of staff.
Two factors needs to be considered here: how to make people follow a budget, and setting the difficulty level of budgeting. There are two main approaches that companies can employ to make their staff heed towards a budget, each having its advantages and disadvantages. They are
Authoritarian method and participatory method, these two approaches represent two extremes. The ideal method that is actually used in practice is the one that strive to achieve a balance between the two extremes.
Again, budgets can either be made so difficult or so easy. For a budget to motivate staff, its level of difficulty must be somewhere around the middle of difficulty and easiness.
EVALUATION: evaluation means to judge something with a sort of standard. The budget represents that target performance which will then be compared with actual performance. And this will then lead to corrective action being taken. Evaluation in real life is not as easy as I have presented it here.
If not handled with, evaluation can encourage actions that will harm the organization in the long run. Again, there are some non quantifiable aspects of a business that is hard to measure. Examples are; customer services, staff morale, innovation, environmental friendliness, etc.
There are non-financial factors that have effects on investment appraisal that must be considered before judging a manager as to whether he or she properly managed the investment under his or jurisdiction. Other business success factors equally needs to be considered.
CONTROL/ CO-ORDINATION: this function budgeting is very important for an organization to grow. Co-ordination simply means ensuring that different parts of the business work in congruence. For example, it will be useless employing sales force that can sell 2,000,000 units of an item when all that your company has the capacity of producing is 1,200,000 units of that product. This is not to say that plans cannot be made to get the remaining 800,000 units from an alternative source, in fact, this is one of the functions of budgeting- to expose weakness so that plans can be made to cover for it.
AUTHORIZATION: budgeting helps to minimize misappropriation and embezzlement that would have characterize corporations if a system of authorization does not exist. Through authorization, managers are made more accountable for their spending. A manager that has been authorized to spend $5,000 dollars in a way will be looking for trouble if she or he spends $5,001 without further authorization. In fact, budgeting helps to prevent fraud.
As you must have seen, we have been able to look at the functions of budget or budgetary system in a business. And it has been revealed that much work is involved than an ordinary person in the street would imagine.
As a manager or an accountant responsible for preparing and ensuring that budgets are implemented, you need to always update your knowledge on budgeting. One way of doing this is by reading posts like this which I am glad you have done. Another way of doing it is by buying and reading some of the books on budgeting displayed below: