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Chapter I. The Nature of Budgeting And Its Functions
1.1. Definition of Budgeting
1.2. Requirements to Budgeting
1.2.1. Integrity of Budget Allowances
1.2.2. Strategic Adherence of Budget Allowances
1.2.3. Prevention From Opportunistic Behavior
1.2.5. Economic Efficiency
Chapter II. Classical Budgeting
2.1. Brief Description of Classical Budgeting
2.2. Performance Profile of Classical Budgeting
2.2.1. The Reach of Budgeting Process
2.2.2. Alignment With Strategy
2.2.3. The Threat of Misuse
2.2.5. Economic Efficiency of Classical Budgeting
Chapter III. Zero-Base Budgeting
3.1. The Concept of Zero-Base Budgeting
3.2. Performance Profile of Zero-Base Budgeting
3.2.1. Integrity of budget allowances
3.2.2. Strategic Adherence of ZBB
3.2.3. Prevention From Opportunistic Behavior
3.2.5. Efficiency of ZBB
List of literature
The present paper purposes to highlight two most well known approaches to budgeting, specifically classical and zero-base budgeting. In last years there is much criticism blaming shortcomings of the both. However, such treatment seems to be biased without deep penetration in the nature of budgeting systems. The paper does not intend to summarise information about approaches to budgeting, but rather to explore system specific features that bring the shortcomings about.
The paper is composed in the way not to contrast the approaches, that is to show the superiority of one of them, but to draw a profile of the approach with respect to selected criteria. The criteria, introduced in the first chapter, reflect major requirements to the budgeting systems from managerial point of view. They encompass integrity of budget allowances, adherence to strategy, impact on employeesí behaviour, flexibility and efficiency. Owing to scarce capacity the paper omits aspects specific to management and organization but still affecting the performance of the budgeting approaches. These are, for example, organization of planning process (bottom-up, top-down, etc), corporate culture, incentive structure, degree of activity formalization, management style, etc.
The second and third chapter discuss instantaneously performance of classical and zero-base budgeting respectively. Analysis begins with brief description of most important features of the approaches and concentrates extensively on how respective approach meets the requirements. Finally, there will be discussed the most suitable type of production which makes up in part for disclosed shortcomings.
Budgeting belongs undoubtedly to the most wide spread financial coordination tools of management. Despite this fact there is no unanimity among theorists about definition and functions of budgeting1. The clear contrast one can observe between American and German concepts of budgeting resulting from different approaches to controlling. Anglo-Saxon point of view regards budgeting mostly as a tool for financial planning, thus as a subject to financial department activities: ìA budget may be considered to be a set of financial statements resulting from a particular scenario- generally the most likely or hoped for scenario. A budget therefore reflects management opinions regarding future financial circumstancesî2. This synonymic treatment of budget and financial plan was adopted from governance practice of public corporate bodies where budgeting embraces comparison of income and outlay entries.
The German doctrine considers budgeting more likely as planning conducted on all management levels and for different time perspectives: ìEin Budget ist f¸r uns ein formalzielorientierter, in wertm‰fligen Grˆflen formulierter Plan, der einer Entscheidungseinheit f¸r eine bestimmte Zeitperiode mit einem bestimmten Verbindlichkeitsgrad vorgegeben wirdÖUnter Budgetierung wollen wir den gesamten Budgetierungsprozess verstehen, d.h. insbesondere Aufstellung, Verabschiedung, Kontrolle sowie Abweichungsanalyseî3.
For the purpose of this paper we will depart from the following budget features:
1. Budgeting is a process of compilation, adoption, and supervision of budgets.
2. Budgets are compulsory by nature, i.e. person in charge has to meet the allotments.
3. Budgeting assigns rather target values than particular actions to departments and delegates certain discretion to responsible managers.
4. Budgeting bases on planning, that is one chooses the most probable scenario under assumption about future sales volumes commodity, and factor prices4.
The role or the aim of budgeting is to govern decision units and departments in the organization towards its goals5. Generally, one distinguishes following functions of budgeting:
- Motivation. By means of performance measurement, evaluation, and remuneration budgeting should direct managers toward companyís goals. This function aims to solve or at least to mitigate the problem of information asymmetry. Personal benefits conditioned to objectives, often expressed in financial form, and participation of subordinates in planning process supplies enough incentives for a man on site not to shirk, but to act on behalf of the firm.
- Coordination. Owing to the overall planning character of budgeting, it facilitates management to overcome difficulties of recourse, profit, and risk interdependencies. Using vertical and horizontal reconcilement enables you to reveal possible bottlenecks and problems as well as counteract erroneous tendencies.
- Communication. For the purpose of effective management subordinates should have sufficient information about organizational goals in order to adjust their actions appropriately. On the other hand, superiors need to be up to date about strategy progress. Budgeting, because of planning procedures suffices this function at least formal.
Budgeting is embedded, in most cases, in overall planning process. It seems to be expedient to highlight the most characteristic features of the process. The reconcilement of department budgets figures is the most time consuming procedure6. The anticipation of coherent company wide performance disposes management to eliminate as many discrepancies as possible in the start-up phase, that is a year ahead.
The next constitutive step embraces supervision of budget progress and current is-to- be comparison, and analysis. As a rule, monthly figures are summarized by managers in charge in form of standardized reports, which have to be submitted to the superior instance. Discovered in this way insufficient executive affords will be corrected by means of either positive, or negative sanctions.
Over the budgeting period, normally a year, companies revise budgeting allowances. If planning office assesses initial premises and assumptions inadequate or erroneous, the costly budgeting procedure will be initiated and target figures will be adjusted.
For the purpose of further analysis, it is necessary to elucidate requirements to budgeting as a company-wide coordination tool. Dilger, in his comprehensive research of budgeting systems, suggests that budgeting has to suffice at least two basic criteria7, specifically to take into account the aspect of optimal performance as well as satisfaction of employee. Despite the first one overlap to certain extent the above-mentioned coordination and information function, it seems to be necessary to precise the requirements.
In present paper, budget consists of two parts: activity program and execution budget. The former prescribes the sorts and actions amount with possible end product figures need to be done in a cost centre. The latter defines resources entrusted to manager in charge to realize preset targets. In practice, these parts are integrated in one document with listed activities and the cost threshold in each entry. Such a matrix form of a budget allowances secures goals adherent behaviour of responsible officials. Determination of activity program alleviates supervision of performance and impedes the temptation on the side of person in charge to neglect some of his functions, i.e. activities in order to meet the budget. Thus, here should be analysed how far such control is possible within particular budgeting system.
The criterion reflects compatibility of organizational (strategic) goals and budgeted activities. One assumes that business units focus their efforts on the budget, not on the strategy. The problem is to design unitsí sub goals in such a manner that there will be no, or at least minimal discrepancy in the long-term development of the organization. Here must be emphasized the extrapolation of past budget figures in overhead domains. Due to absence of clear cost drivers executive budgets are often planed in a lump sum without critical examination of activities bundle.
The problem of motivation has to meet two challenges simultaneously. On the one hand, manager must satisfy personal demands, for example career, remuneration, working atmosphere, etc. On the other hand, he must act on behalf of the organizational goal. With respect to particular approach, it should be assessed its inherent incentives contributing to fulfillment of the criterion and preservation of interest equilibrium.
During the test on flexibility one should examine the ability of budgeting system to absorb environment complexity. To wit, one should analyze which features and procedures of each budgeting system facilitate reaction on, for example, shift in consumersí behaviour, competition, etc. by means of adequate action alternative.
At this point should be assessed the overall man-hours that consumes budgeting process in the organization. More precisely it implies the number of executed procedures and requisite expertise of involved employees.
Classical budgeting aims on profit maximizing of the organization, that is sales less costs8. One ranks this system as gradual budgeting process and it is very similar to standard product costing. It serves mostly as underlying for the statement of income. Organizations budget sales and costs separately within the scope of classical budgeting. The reason for this is the chief aim of profit maximizing.
The process of budgeting starts with sales estimations made on the strategic management level. These estimates make the basis for further quantitative targets. Next, it will be determined a production plan with respect to inventory movements. The production program, on its part, has an impact on commodities procurement. These budgets constitute activity program for the budgeting period. After evaluation of physical sales volumes, commodities, and output, one gets an expense budget expressed in monetary units. The underlying for evaluation are expected sale and acquisition price, and unit costs rates. Eventually, every production center receives a task schedule, which must be executed with regard to preliminary calculation.
Expense budgets for overhead domains like business administration and R&D department, for example, result from lump sum calculation, that is simply adjusted on inflation or other external factors. Noteworthy is the fact that classical budgeting imposes no action programs for these departments.
Further, all fractional expense budgets, after been approved, are aggregated to the corporate statement of income, which clarifies expected operational profit. Owing to internal interdependencies department budget are not been planned in a consequential way, to wit production budget follows sales budget and the former impacts R&D and so on, but rather simultaneously.
1 Cp.: Horv·th (2004), pp. 68.
2 Altman (1986), pp. 17.
3 Horvath (2001), p. 233.
4 See: Pfaff (2002), pp. 232.
5 Cp. Ibidem, p. 233.
6 Cp. Horvath (2001), p.247 et sqq.
7 Cp. Dilger (1991), p 102.
8 Cp. Dilger (1991), p 39.
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