Manage and Understand the Purpose of Budgets
You may be worried about many issues when it comes to budgeting. Budgeting is dealing with money, the organisation / company’s money, sponsor’s money, other private funder’s money, depending on how the organisation / company functions, but in every scenario, you are dealing with money.
You may have so much going on, complaints from customers, problems with suppliers, service providers may have shut down; you may be thinking of adding that little bit extra money on top of last year’s budget, just in case! Handover the developed budget on to an accountant and then relax! Or planning to spend everything allocated on a budget! Or having thoughts that remaining within a budget will prove you to be an efficient employee / budget manager! No, the answer is NO. You need to take responsibility for each action and part of the budget, understand the purpose of budgets and know how to manage them.
Budgeting is not a simple process that is developed and left as such, but it is an ongoing system that needs monitoring, controlling, recording, reporting and many more while following the organisation’s legal and regulatory requirements. This in itself is self explanatory, telling us that the budgeting procedure does not stop with developing and agreeing budgets, but involves the huge responsibility of managing budgets; that is what businesses are all about; you can never say that you have nothing left to do, there is always some work or the other.
This hub is based on the NVQ Level 4 unit "Manage Budgets" and has a credit value of 5.
1: Understand the purpose of budgets
1.1 Explain the purpose and benefits of managing financial resources effectively and efficiently.
Managing financial resources effectively and efficiently is a standard for financial and performance management and this means, reasonable value for money. Efficiency in managing financial resources means that the business is achieving maximum performance with minimum input and with very little waste. Effectiveness in managing financial resources means that the business is able to provide / deliver services and products successfully by meeting all its goals and objectives.
“Managing financial resources means using funds effectively, efficiently and economically.”
The purpose and benefits of managing financial resources effectively and efficiently are:
- You have a short term plan for the company’s expenses; usually for a period of one year.
- You will have a good idea of allocation of financial resources, the goals or objectives for which each financial resource will be allocated and be ready to look for alternatives in case of any issues; in other words, cash flow will be adequate and perfect
- You get maximum benefits for money that you spend.
- You can look at the costs and the benefits of each objective or goal and prioritise accordingly
- You get a chance to assess different objectives and fund the most cost effective one
- You can specify goals and objectives for the budgeting period.
- When an objective/goal/task does not go by the normal flow but has deviations from the actual plan, you are able to evaluate the reasons for the deviations and take necessary actions to correct them.
Business Budgets are Essential Management Tools
- You can avoid over expenditure, under expenditure and also cover unexpected expenses
- You are able to plan and control the money or finances and this is done by constant monitoring, evaluation and reviews.
- You are able to make any required changes only if proper management of financial resources is in place
- It improves the overall operation of the company / organisation
1.2 Identify legal, regulatory and organisational requirements for managing a budget.
For organisations depending on their mode of operation and dependence on government and other systems, the management of budget needs to adhere to legal, regulatory and organisational requirements. Budgeting is a complex process and must be integrated with the organisation’s strategies, services, values, aims, etc.
Some of the legal, regulatory and organisational requirements for managing a budget are:
- Performance monitoring against the organisation’s budget
- Consistency in budgeting
- Accuracy and transparency in budgeting
- Be wise and avoid mistakes in managing budgets
- Strong and firm estimations for the budget
- Adequate (minimum level of) resources to fund various services that are necessary for the functioning of the organisation
- Report on any shortfalls well in advance to the organisation
- Monitor budget and control thereby improving performance
- Take necessary actions in case of shortfalls or over spending
- The financial planning system needs to be accurate and spot on.
- Any changes in services need to be forecast, changes in policies need to be replaced with alternate ones and forecast the costs for the future
- Meet demands, resources should match expenses
- Review performance against budgets, prioritise items on budget depending on importance of service deliveries
- Always have records of estimates for the future
- Have long term plans in hand
- Have detailed guidelines on various spending with reasons
- Refer to previous year’s budget and use it as a base, look for service changes, cost changes, etc
- Decisions are made by a board or committee who are involved with finances and budgeting
- Involve people who will be directly dealing with budgets
- Look at the implications of each item on the budget, the organisation’s objectives, goals set, practical facts about the budget, etc.
- Plans and reserves need to be ready in times of deficit
- Have proper monitoring, controlling and reporting + reviewing procedures for budgeting
1.3 Describe different types of budgetary systems and their features.
Budgetary systems are part of the planning and controlling process of a business. When planning businesses, it could be a short-term plan (less than a year), a long-term plan or a medium-term plan. Depending on the plan, the type of organisation and taking into account various facts involved, you should be able to choose the right type of budgetary system. There are various types of budgetary systems. We will look through a few among those and their features.
Types of Budget
In this type of budgeting, the information and figures from the previous year are taken into account and the budget is created for the following year with minor variations wherever necessary. These budgeting systems are easy to develop and implement. They are cost and time effective too. However there are some drawbacks in using this system as they follow the top-down budgeting process where budget is imposed by higher management. They are also not very flexible and cannot be used for long term budgeting systems.
Activity based budgeting (ABB):
Budgeting here is based on the activities that caused an expense. Based on the activity, and how it benefits, resources are allocated. These are highly accurate in the sense, tracking of costs for each service / objective is easier. It consumes lot of time, is complex and costs more.
These are short-term budgets where budgets are added for each rolling period. For example, a budget could have been developed for just 3 months and when this period expires, new budget will be added taking into account the facts and figures from the previous rolling period. As this budget looks at short term plans, the budgets are always up to date and realistic. It requires more time as budget has to be prepared quite often (every few months) rather than once a year.
The budget is prepared by the top management and is passed on with authority to the employees in the organisation. These are common in small organisations or new businesses. Sometimes managers who lack budgeting skills, not aware of the positive outcomes of other budgeting systems, impose budgets on employees using this process. However this may not be the case always and sometimes not all employees will agree to the budget. This budgeting procedure is less time consuming and may need motivation for agreement.
Managers come together for discussions and make decisions on budgets. This is exactly the opposite of top-down budgeting. Skills and ideas from various people are brought together when developing the budget and hence the quality of the budgeting process is good. These systems are used in big organisations / businesses that are well established. The managers involved will have good budgeting skills and ideas are gathered from experienced staff in each department. This type of budgeting is time consuming.
Zero-based budgeting (ZBB):
Budgets in this case are prepared from base level, that is, from zero base. In the process of zero based budgeting, all tasks / services are prepared which will help with achieving the organisation’s objectives. Managers decide on the priority of each service based on how the organisation will benefit. Based on this priority, resources are allocated. Some areas in which ZBB can be used are, training, R&D, not for profit services, etc. This is a very effective form of budgeting system, but consumes lot of time. Managers need to be highly skilled in order to develop a ZBB system.
This is a type of budgeting system where any anticipation in increase or decrease in income for the business is taken into account while developing the budget. This type of budgeting is straight forward and effective cost wise, but will not include any other expenses like one-off expenses, emergency expenses, etc. This is a very easy and quick form of budgeting and can sometimes lead to errors in allocation of resources.
Making a Budget : What Are the Different Types of Budgeting?
Profit-motive based budgeting:
This type of budgeting is based on profit achievements; that is, based on the amount of income or profit expected for a particular financial year. Most businesses use this type of budgeting as a common method of budgeting, but cannot be considered a formal method of budgeting. As this budget is based on profit motive, if sales are affected, it will affect the budget too.
For a detailed understanding of how to manage budgets, which is the second part to this unit, please follow the link below
To get an idea and understanding of how to report performance against budgets, please follow the link below, which is the third part to this unit.
I hope you find the information here useful. Please do not hesitate to leave your thoughts, ideas and feedback if any.
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