The main function of management accounting is the creation of the annual budget and its use as an auxiliary tool for controlling the operations of the organization. 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 the budget, the company’s long-term goals are associated with its daily activities. In the absence of a budget, with all their desire to work together, employees may veer from the work plan outlined by management. For example, designers of a bicycle manufacturing company can try their best to improve product quality without realizing that the primary task is to produce the maximum number of units at the lowest possible price.
The budget performs the following functions:
- Coordination of the enterprise.
- Setting goals and standards.
- Determining the need for resources.
- The motivation of management personnel.
- Creating a basis for performance evaluation.
Effective administration is the key to budgeting. The enterprise should have some kind of a budget committee to control the process, which, depending on the size of the enterprise, can take from several weeks to many months. To create a budget, they sometimes gather a special team consisting of managers of the enterprise, or they involve external consultants.
The budgeting process usually consists of the following eight steps:
- Informing all participants of the process of the overall strategy of the enterprise, budget requirements and priorities.
- Identification of limiting factors that may affect production or sales.
- Preparation of the sales budget. This process is usually closely related to the production budget.
- Preparation of budgets of structural divisions.
- Preparation of a preliminary budget to determine discrepancies between production and sales, calculation of expected profits, costs and revenues.
- Conduction of meetings at the departmental level to ensure internal consistency of the budget and its alignment with the overall strategy of the organization.
- Consideration of the final version of the budget and its adoption. This is the responsibility of the budget committee and the management team or representatives of the consulting firm.
- Informing all managers about the main features of the budget and their responsibility in the process of its execution. If necessary, it is possible to conduct pieces of training for the personnel on budget monitoring and budget implementation.
The next stage is the development of a general budget, which contains the most important information for the next year. It contains three key elements:
- Budget report on profits and losses. Usually submitted as a summary and a series of monthly reports showing the level of sales or profitability, the key elements of sales-related costs, overheads and operating profit. In addition to the reports, graphs illustrating the calculation of cost and costing, detailed budgets for each structural unit and other specific information relating to the activities of the enterprise are attached.
- Budgetary report on the financial situation. It is usually created at the beginning and at the end of the year, but monthly balance sheets can be compiled.
- A budget report on the financial condition, usually a month or a quarter.
These reports are of critical importance and should be considered by a full-fledged budget committee. For example, a company’s budget may show a significant increase in operating profit for the year, but, nevertheless, need to be reviewed if it turns out that a loan overdose within six months has reached an unacceptable level.
Each organization faces its own specific financial problems, but the next three are most common:
- Additional “sagging”, which is the deliberate underestimation of budgeted revenues (or revaluation of expenses) by managers. This is done in order to make their goals more achievable. This is a fairly common problem in multi-level companies, where the budget is passed up the management ladder. In case of accumulation of inconsistencies, the final budget will be very distorted. This problem is extremely difficult to resolve. One of the possible options that have proved their effectiveness is the establishment of trusting relations within the company to prevent the introduction of unauthorized changes. As a result, at each level of management, a realistic and realizable budget will be developed.
- The occurrence of a limiting factor. For example, a sales department could sell 10,000 units a year, but production capacity is only 6,000 units, even under conditions of maximum utilization. The company can expand production within a year, but during the discussion, it may become clear that the deficit can be covered by attracting additional suppliers.
- Inability to take into account all the consequences of budget decisions. Since budgeting affects a complex structure of relationships, it becomes very important for management accounting to ask the right questions when considering a budget project. For example, because of a large number of wastes, it is necessary to increase production efficiency in the coming year, without introducing changes in the rest of the company. For this, it is necessary to determine a suitable method for solving this problem. 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.