Budgets play an important part in planning, organising and controlling operational activities. Through participative budgeting, managers at all organisation levels actively participate in preparing their budget estimates.
Advantages of participative budgeting include:
- Improved communication
- A greater understanding of the factors involved
- The opportunity to consult with other managers at budget meetings
- Improved commitment and acceptance of the budget
- The manager’s expertise will enhance the quality of the budget.
Enhance your understanding by watching the following 12.36-minute video.
This “bottom-up” approach may result in a more accurate budget and a greater personal commitment from employees. However, the downside to this approach is that the budget may become “padded”. Padding the budget occurs when targets are made easier by under-estimating revenue and over-estimating expenses. This gap is referred to as “budgetary slack” and is the difference between the budget estimate and the true estimate for the planned operations. Managers may implement this procedure to make it easier on themselves by reducing pressure or to achieve bonuses for reaching budget targets. The procedure, however, may be implemented in times of uncertainty, which could result in budgetary cuts.
Budgets are used in all areas of the organisation, and all levels of management are responsible for the outcome. If the principle of management by exception is followed, management becomes more efficient. In this instance, the manager does not waste time investigating the areas of responsibility already performing to expectation but instead concentrates on the exceptions. The time saved by managers can be better spent planning and coordinating activities under their control.
While the main focus is on financial performance, management will also need to obtain information concerning non-financial indicators such as:
- Market growth
- Level of customer satisfaction
- Return on investment to shareholders
- Research and development
- Staff training
- Measures of environmental and social responsibility
Budgets should be used to motivate staff where organisational objectives and goals are linked to employees’ personal goals; otherwise, resentment, lack of motivation, and stress may result. The challenge for managers is to provide budgetary figures that are neither too easy nor too difficult to attain and to set targets that are realistic and achievable.2
Policies and procedures for budgeting and forecasts may include the following features:
- Budget variations
- Financial planning
- Reporting and documentation
- Budget approvals
The most commonly used tools to identify the risks associated with the planning process are PESTLE and SWOT analyses; both tools make provision for internal and external influences:
PESTLE: Looks at various issues, including:
- Political issues such as legislation
- Environmental includes climate and weather changes
- Social/Socio-economic focuses on demographics
- Technological factors include delivery lead times and quality of goods produced or procured
- Legal impacts affect costs, distribution rights, import duties, labour, etc.
- Economic issues cover possible global recession, increased interest rates, and an increase in inflation rates.
Further Reading
Read more information about using PESTLE analysis for forecasting and budgeting.
SWOT Looks at areas including:
- Strengths (internal) what makes the business successful
- Weaknesses (internal) what the business doesn’t do well
- Opportunities (external) that the business can incorporate to improve
- Threats (external) that can negatively influence the business.
Further Reading
Preparing a cash flow forecast and ensuring effective budgeting processes.8
Risk factors that impact budgeting and forecasting processes include the firm's size and ability to leverage discounts, obtain approvals, negotiate shortened delivery times, and receive improved customer service from suppliers.
Procurement options vary with the ability of the business to keep stock or appoint contractors long-term and their preferential payment cycles for small suppliers. Internal risk factors include the quality of the product or service and price structure compared to competitors.
The policies and procedures governing budgeting, forecasting, and cash flow planning need to adhere to the code of ethics of the industry in which it operates.
Further Reading
Budgeting and Forecasting policies and procedures
You may not need a budget policies and procedures manual if you're a sole proprietor and only one person. As your company grows, you may have to add additional staff members; if you start a business, your board of directors will also need to be considered. Having a manual that clearly describes your financial policies and procedures for your company may seem appropriate when you start as a single employee.
In some circumstances, creating a sample procedure may be advantageous. Initiate a plan for the business by setting business goals. Use particular strategies to determine fixed costs, such as ad costs, mortgage payments, and your employees' wages. List variable costs for public art, such as overtime. Draw up projects that support or build on the goals you've set. Estimate the cost of the project and evaluate your profit margin.
You'll want to have a set of standards for a budget review every so often to see how closely you stick to your budget. If a genuine emergency requires additional funds, you'll have to modify your spending strategy. If one of your departments makes unwise spending choices, you may have to rein them in or spend less in another part to balance it out.
The policies and procedures library from the University of QLD makes a great model.
Further Reading
Organisations also need to implement the ethical corporate governance principles as outlined by ASIC concerning the role of directors.
The director’s role in corporate governance
There is a great deal written about corporate governance. But fundamentally, the principles of good governance are familiar to all good directors. Good governance goes hand in hand with a director’s role, either as a manifestation of how a director’s duties are fulfilled or as a support in performing these duties.
For instance, corporate governance is concerned with:
- the quality of information flow within the company – this supports the board performing an oversight role in the company
- Dealing with conflicts of interest, transparency and accountability to shareholders – a director must act in good faith and the company’s best interests5
Although the Australian government focuses on regulating the securities and exchange management principles, these same principles apply to private businesses unrelated to stocks and investments. There are a number of that laws help businesses to act with integrity and a high ethical standard.
The Corporations Act 2001 consolidates many other laws to ensure management and business owners have the best interests of their customers in mind at all times.
Read more for a comprehensive list and links to the laws incorporated into the Corporations Act 2001.6
