Accounting and finance principles

Accounting/Finance

Identify the stages of the budgeting process and evaluate their effectiveness.

There are four stages in most budgeting processes. The first stage is information gathering. At this stage past performance results are collected and assessment is made of the company's strategic plans. Performance results for the previous year are gathered, the company's current objectives are defined and the market in which the company operates is evaluated. Some companies also include customer feedback in their information gathering tasks.

Planning is the second stage, with determinations made about how detailed the budget will be and how it will be organized, whether by department or product or other groupings.

Preparing the budget is the third stage. The information obtained in stages one and two is converted to numerical values. Finally, financial projections are created concerning revenue expectations, projected expenses and any capital expenditures included.

Control is sometimes not considered part of the budget process; however, because the results are recorded all year and, at year-end if not before, variances are noted and assessed, it becomes part of the continuing budget process for the following year's budget as well.

Some say that one is only as good as the information one has; in that sense, properly collecting information for the budget process is likely to be the single most effective component in creating a successful budget. Planning, however, is equally important: it is the aspect that creates the uses for the information gathered in the first stage. If stages one and two are properly completed, stage three should easily fall into place. Control is one facet that needs 'hands on' attention; if it is properly carried out, however, it can make the next year's budget even easier to prepare and more seamless to carry out.

2.Evaluate the level and validity of detailed assumptions used to create budget estimates.

Assumptions are, by their nature, representations of the unknown. Because of this, it is important to base those assumptions on the most reliable information available so that fear of error can be minimized and planning can proceed. There are several "necessary assumptions," such as sales levels, gross margins, accounts receivable levels, bad debt percentages and so on) that cannot be known but cannot be relatively reliably projected based on input from key people. One way to test the assumptions would also be to ask those key information providers how they intend to improve their department in the coming year, and then determine whether their plans are realistic based on the information they have provided. This will also help budget preparers to document the factors on which assumptions used in budgeting are based.

3. Discuss the role of the budget as an analytic tool that can be used to evaluate organizational performance.

Budgets create, first of all, leverage to pressure business units to improve; they can also be used to determine whether or not departments have improved.

In addition, "the budget process has always been and always will be the place where everyone raises questions of the efficiency, economy, effectiveness, productivity, impact, and results of government activities.

Third, the power of the purse is a formidable weapon in getting results.

And, finally, only budget offices can stimulate, goad, and even inspire agencies to strengthen their programs, operating systems, and organizational structures" (Miller & Rabin, 2001, p. 7).

When budgets are used to gauge performance, most subjective content is removed from the assessment.

Because the numbers -- what was budgeted and what was actually spent -- are easily compared, it is difficult to draw inferences not supported by at least financial truth regarding any department or program.

4.Explain how the budget can be used to find and eliminate inefficiencies in an organization's performance.

Simply, budgets can be used to find and eliminate inefficiencies when performance of the company (departments) is taken into account vis-a-vis the current budget and the previous year's budget. Aside from the gross assessments concerning whether or not a department has met its goals within budget or over budget (or under budget for that matter), materials and labor costs for each department or business unit can be compared with the same areas in previous years; in addition, of course, those areas have to be assessed against production (where possible) this year and in previous years to find the relative percentages of expense vs. production/income and so on. Some companies also include quality assessments as part of their analysis of department efficiencies.

5.Explain the role of the budget in the business control cycle.

Budgets can be used to help a firm meet goals and objectives. The business control cycle consists of four steps. The first is setting the standard, that is, creating the budget. The next is recording the performance of the company's departments. Third, variances from the budget are identified and analyzed to understand why they occurred. Finally, action can be planned to either correct problems identified this way, or to put preventive measure in place to enhance future performance.

6.Analyze internal and external control mechanisms that can be put in place to monitor and evaluate the budget.

Internal control mechanism could include consistent follow-up on internal and external audit findings and reporting findings of internal audits to the head of the organization or governing board. External control mechanisms are the external audit: since the Sarbanes-Oxley Act, it is generally prohibited for external auditors to conduct internal audits, making it less likely that there will be ethics problems regarding internal or external audits. However, adding a due diligence function to the internal audit function, to both oversee internal audits and to evaluate external audits and recommend action, is also more prevalent since Sarbanes-Oxley.

7.Describe how the budget can be used in the performance accountability and reward process.

The budget can be used both directly and indirectly in the accountability and reward process. In using budgets for accountability, comparing a manager's expenditures to those in the budget will provide a gross idea of whether there was a cost savings or cost overrun; it will take additional information, such as inventory figures, quality control statistics, human resources statistics, sales figures and so on, to determine whether the manager (department, etc.) performed well or poorly. Therefore, while the budget alone will not provide all the answers, it provides the substrate upon which the answers can be constructed. In determining rewards, somewhat the same principles hold: using the gross comparison of expenditure to budget will not provide all the answers, although it does form a basis for determining whether a manager or department has outperformed its mission, or offered substandard performance. Rewards can be offered appropriately; however, there is one caveat concerning making cost savings into a direct reward for a manager. While it is sometimes done, it also tempts the manager to cut corners in essential business functions in order to achieve savings that might then accrue to him or her.