The main function of management accounting is the preparation of the annual budget and its use as an auxiliary tool for controlling the organization’s operations. The structure of the budget and the process of its formation will differ depending on the size and nature of the enterprise, but some basic principles have found wide application.
With the help of a budget, the company’s long-term goals are linked to its day-to-day activities. In the absence of a budget, employees, despite their desire to work harmoniously, may deviate from the work plan outlined by management. For example, the designers of a bicycle company may be working hard to improve the quality of the product, not realizing that the first priority is to produce the maximum number of units at the lowest possible cost.
Therefore, the budget performs the following functions:
- Coordination of enterprise activities.
- Setting goals and standards.
- Determining the need for resources.
- Motivation of management personnel.
- Creating a basis for performance evaluation.
Effective administration is a key point in budgeting. The business should have something like a budget committee to oversee the process, which, depending on the size of the business, can take anywhere from a few weeks to many months. To create a budget, sometimes a special team consisting of company managers is assembled, or employees of consulting firms are involved.
The budgeting process usually consists of the following eight steps:
- Informing all participants of the process about the general strategy of the enterprise, budget requirements and priority tasks.
- Identifying factors that may limit production or sales.
- Preparation of the sales budget. This process is usually closely related to the production budget.
- Preparation of budgets of structural subdivisions.
- Preparation of a preliminary budget to determine discrepancies between production and sales volumes, calculations of expected profits, costs and revenues.
- Holding meetings at the departmental level to ensure internal consistency of the budget and its compliance with the overall strategy of the organization.
- Consideration of the final version of the budget and, if it is satisfactory, approval. This is done by the budget committee and a team of managers or representatives of a consulting firm.
- Notification to all management personnel about the main features of the budget and its responsibility in the implementation process. If necessary, trainings on control and monitoring of budget implementation can be conducted for staff.
At the next stage, the general budget is developed, which contains the most important information for the coming year. It contains three key elements:
- Budget report on profits and losses. Usually presented in the form of a summary and a series of monthly reports showing the level of sales or profitability, key elements of costs related to sales, overheads and operating profit. In addition to the information, graphs illustrating costing and costing, detailed budgets for each structural unit and other specific information related to the enterprise’s activities are attached.
- Budget report on the financial situation. It is usually created at the beginning and end of the year, but monthly balance sheets can also be drawn up.
- A budget report on the financial situation, usually for a month or a quarter.
These reports are critical and should be considered by the full budget committee. For example, a company’s budget may show a significant increase in operating profit for the year, but still need to be reviewed if it turns out that overdrafts have reached an unacceptable level within six months.
Every organization faces its own specific financial challenges, but the most common are the following:
- Additional “sag” is a deliberate underestimation of budgeted revenues (or overestimation of expenses) by managers. This is done in order to make your goals easier to achieve. This practice is quite common in multi-level companies, where the budget is passed up the management ladder. If inconsistencies accumulate, the final budget will be very distorted. This problem is extremely difficult to solve. One of the possible options, which has proven its effectiveness, is the establishment of relations within the company to prevent arbitrary changes. As a result, a realistic budget will be developed at each level of management.
- The appearance of a limiting factor. For example, the sales department could sell 10,000 units per year, but the production facilities, even at maximum capacity, can only supply 6,000 units. The company may expand production during the year, but in the process of discussion it may become clear that covering the shortfall is possible through the involvement of additional suppliers.
- Inability to consider all consequences of budgetary decisions. Since budgeting involves a complex structure of relationships, it becomes very important for management accounting to ask the right questions when considering a budget project. For example, due to a large amount of waste, it is necessary to increase production efficiency in the coming year, without implementing changes in other divisions of the company. For this, it is necessary to determine the appropriate method of solving this task. The solution may be the need for capital investment in upgrading equipment, which may affect other elements of the capital budget, financial position and condition.