Budgeting is not an exact science, and its success depends on the precision of estimates. Estimates are based on facts and managerial judgment, which can suffer from subjectivism and personal biases. The accuracy of budgeting therefore rests on the adequacy of management. Where management is optimistic about future prospects for the company, they are likely to dram up positive or high revenue growth estimates, but such targets are usually difficult to attain due to variances between expected and actual performance. The crucial aspect of budgetary control is the comparison of actual performance based on actual level of an activity or a period, with the budgeted performance level based on the budgeted or expected results.
The recent worldwide recession began in the United States, as a result of the overheated housing markets, consequently causing banks to fail. Due to the connectivity of financial institutions, the recession spread from the US to Europe, and other parts of the world. Local governments across the world were subjected to sudden budget squeezes due to declining revenues, rising costs of public service and social aid to members of the public affected by the recession, bailouts and costs of fiscal stimulus programs (Council of Europe, 2010). All these programs took a huge toll on national budgets of countries experiencing the recession, thereby increasing national budget deficits.
The severity on the effect on the budget due to economic downturn has relied on numerous variables, for instance the magnitude and timing of the recession. Government response policies also affect the impact on the budget. A government that compensates local governments in case of shortfalls in revenue due to the economy may minimize damages to employment and general demand. Some governments are forced into austerity measures in order to tackle budget deficit problems.
The vulnerability of budgets to changes in revenues plays a major role on the severity of budget squeezes. Businesses that experience volatile demand due to the nature of their industries are more likely to be affected by a downturn in the economy than businesses that have relatively stable income bases. Similarly, local governments that rely on a large part on personal income taxes will be diversely affected due to declines in jobs, salaries, or hours in an economic downturn.
The budget preparation process takes significant time and resources in activities such as planning, budgeting and forecasting. Budgets are important for a number of reasons, for instance stating an organization’s expectations, or goals, in clear and formal terms in order to avoid confusion and facilitate their attainability. Budgets communicate expectations of the organization to all concerned with the management of the organization, including top management, employees, shareholders, analysts, creditors and rating agencies (Hansen, Mowen and Guan, 2007).
Budgets are used to provide a detailed plan of action fro reducing uncertainty and for the proper direction of individual and group efforts to meet performance targets. They coordinate activities and efforts in such a way that optimizes the use of organizational resources. Budgets also offer a way of measuring and controlling performance of individuals, departments and the organization as a whole, and provision of data on the required corrective act to be under taken. For these reasons, budgets are essential for the achievement of organizational objectives, and help in making decisions that affect the cash flow position of the organization.
Despite the effort, time and resources used in the budgeting process, most budgets fail to deliver the intended benefits, according to a survey by PricewaterhouseCoopers (PwC) (Jarman and Bibekar, n.d.). According to the PwC 2007 survey, companies will usually take more than three months to complete and agree on an annual budget, meaning that the budget will be outdated by the end of the first quarter since most of the data gathered does not reflect on changing environmental conditions. In the survey, 40 per cent of the respondents expressed a desire to see an improvement of accuracy from the budgetary process.
The budgetary process is not always accurate since a significant amount of time is spent on data collection, which leaves some organizations to use inappropriate tools such as ERP (enterprise resource planning) software to prepare their budgets thereby rendering the budgeting and planning process ineffective.
Because of the unpredictability of the future, some could argue that the budgetary process is irrelevant. The installation of a perfect system of budgeting is not possible in a short period because business conditions change rapidly with little or no warning (DeCoster and Schafer, 1976). For this reason, the budgeting program should be continuously adapted. The budgeting process should be a continuous exercise since it is a dynamic process. Management should not lose patience, and should go on trying various techniques and procedures in developing and implementing the budgeting system. In so doing, the organization will be able to reap the benefits of budgeting.
An organization’s budgeting system should be flexible enough to take advantage of all opportunities that arise from time to time and are not covered by the budget. Inflexibility impairs the initiative and freedom of managers in making decisions. A rigidly administered budgeting program dominates the organization and imposes strict rules in implementing the budgets. In such a situation, the organization will be slow to react to changes in the economic environment and could be forced to cut costs through downsizing or cutting investment projects, which could all undermine the success of the company in the future.
On the other hand, if the budgeting program is administered in a flexible and sophisticated way, managers across departments will get better freedom in applying the budgeted plans and resources. A flexible and comprehensive budgeting program allows the organization to readjust plans more effectively when new situations occur, in a timely manner (Kinney and Raiborn, 2008). The principle of flexibility is particularly significant in cost control. The chief advantage of a flexible budget lies in the fact that performance can be evaluated in a realistic manner. Variable budgets are employed to make meaningful comparisons of the actual and budgeted expenses when anticipated circumstances change.
The budgeting process is not perfect, but the advantages of implementing a budget outweigh the disadvantages of preparing the same. With the recent economic downturn, most organizations are trying better forecast cash flows; prioritize on projects that have positive cash flows in the near future, balance cost reduction with company objectives, and better prepare their budgets for future.
During economic downturns, companies could do better by prioritizing on projects that offer the most revenues and positive benefits in a short period of time, instead of cutting back on costs across the board. Some projects could be deferred, especially those that offer benefits at a later date. Organizations could award less than 100 per cent on budget requests made by departments through considering low cost alternatives in accomplishing goals.
Reference list
Council of Europe, 2010. The impact of the economic downturn on local government in Europe. Budapest: Local Government and Public Service Reform Initiative, Open Society Foundations. Web.
DeCoster, D.T. and Schafer, E.L., 1976. Management Accounting: A Decisional Emphasis. New Jersey: John Wiley and Sons.
Hansen, D.R., Mowen, M.M. and Guan, L., 2007. Cost Management: Accounting & Control. New York: Cengage Learning.
Jarman, N. and Bibekar, S., [n.d]. New Era Budgeting. London: PricewaterhouseCoopers. Web.
Kinney, M.R. and Raiborn, C.A., 2008. Cost Accounting: Foundations and Evolutions. New York: Cengage Learning.