Businesses usually carry out various activities in pursuit of their organizational objectives. These objectives differ from organization to organization depending on the nature of their business. However, there are those functions that are common in almost all organizations such as planning, budgeting, strategizing and performance measurement.
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These functions usually help the organization to streamline itself towards the achievement of set goals and also to analyse how far it has gone in ensuring that the goals set are being implemented. The following paper seeks to answer several questions that relate to business functions.
Purpose of budgeting within organizations
Budgets are simply put a plan of revenues and expenses. By a plan, we mean a preparation of ways to spend or save. The word comes from the French word ‘bougette’ which means purse. Budgets are an important in economics due their efficiency in harmonizing and monitoring the monetary issues in an organization (Atrill & McLaney, 2003).
With a budget, organizations are able to set their goals clearly and allocate the necessary resources in monetary terms that are needed for those goals to be accomplished.
The purpose of a budget is twofold; first it enables the organization to forecast its expenditures and revenues such that the business can predict how it will perform financially within a given financial year. The other purpose is that it enables the business through forecasting to measure its actual financial operations.
This is possible through annual budgets that are compiled as a concerted effort across the various departments such as human resources, IT, operations etc. All these departments provide a comprehensive list in total of all the organization’s expected revenues and expenses.
The actual intended effect of budgeting is to come up with a financial plan that would be used as a blueprint for the company within the year. Managers from the various departments are therefore expected to be cautious in their spending so as to ensure that there is minimum deviance from the budget.
Therefore at the end of the financial year and after auditing of the various departments, it is possible to point out the areas in the company that are well managed and those that can be considered to be ‘out of control’. We can therefore see the importance of preparing a budget since without it; the organization would be an ‘unruly horse’ of sorts.
Relationship between objective budgets and operational budgets
As stated above, budgets are lists of the company’s anticipated revenues and expenses. However, there are various types of budgets. These include operational budgets and objective budgets. While the two are not the only types of budgets, they are a classification based on the manner of budgeting.
Generally, operational budgets are based on a detailed projection of the organization’s anticipated revenue or expenses that is based on the available data such as sales in the past year, past expenses and emerging patterns (Atrill & McLaney, 2003). Importantly, these budgets are usually short-term and relate to particular departments e.g. sales, production etc.
On the other hand objective budgets are different in the sense that they are based on ‘what ought to be’ and not ‘what has been’. This is principally why they are referred to as objective budgets. They are usually long term in nature and they target the general organization.
They are mostly characterized by setting targets that must be met by each individual department. Nevertheless, the two types of budgets are not mutually exclusive; the company can have an overall objective budget but have short-term operational budgets being run by certain departments.
Factors to consider while budgeting
Though budgeting may sound easy, it is actually quite difficult to prepare. There is therefore a need to follow a set guideline to achieve the intended purpose. The first factor to consider while budgeting is the total annual income. Here, the income refers the immediate previous financial year.
This provides a good starting point in projecting future income. Next, there must be a consideration made for total annual expenses for the same reasons (Atrill & McLaney, 2003).
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Once, the organization has obtained the data on expenses and income, the next thing to consider is the analysis of the data with the organization’s goal in mind. This involves isolating the particular areas that seem to be non-performing according to previous budgets and set targets and setting remedial measures.
The organization should then task the function of implementation of a new budget upon certain individuals. Lastly, there must be a periodic review of the stage of budget implementation either monthly or quarterly.
How budgeting assists a business to achieve its aims
Budgeting is very important to an organization. First it acts as a roadmap or blueprint that enables the business to account for every penny earned or spent. It thus assists the firm to set its sight on a target without having to worry about how the target will be met since there are already set mechanisms. Secondly, budgeting will assist the business to note the occurrence wastage and to set up remedial measures.
Next, budgeting assists the organization to align its priorities since it avoids the conflicts that would arise from arbitrary spending. Additionally, a budget helps the organization to reduce the workload of managers since they do not have to keep making proposals every time they need to spend. Again, it puts a cap on spending which is essential for directing resources at the important goals.
Budgeting also assists the business to build teamwork since various persons come together to prepare the budget (Atrill & McLaney, 2003). It also transforms money to become a tool for achievement of goals and not a source of conflict.
Profits are better cultivated where there is a budget since there is a clear indication of expected revenue and expenses. Finally, budgeting assists in ensuring that the organization checks on its debts and grows its savings which is good for long-term sustenance of business.
Performance measurement is a critical tool for any organization. It enables the organization to assess its progress and set goals for the future. Without any kind of performance information, the organization would not know whether it is making progress or it is declining. Performance measurement indicators include things like reports, periodic reviews and audits.
Importance of performance information to a business
The main reason why organizations measure performance is to improve it. Simply put, it is impossible to improve what one does not know. Behn (2003) states that for those measures that are not related to improvement, they can be attributed towards the overall achievement of organizational goals.
He proceeds to suggest that there are eight reasons why performance information is important to any organization. These reasons are discussed hereunder.
The first reason why performance information is vital is the need for evaluation. To achieve this, the evaluating managers need to know the organizations’ goals (Kravchuk & Schack, 1996). Behn (2003) states that evaluation consists of two variables the first of which is the performance data itself and the other is the benchmark through which data is analysed.
To acquire the performance information, there must also be focus on a particular department’s performance at a time upon which the output of such an agency is measured based on its overall effectiveness, cost effectiveness, impact or value to the organization and finally its adoption of best practices.
Another key reason is control. Through performance measuring, the line managers can effectively tell whether their subordinates are following instructions. While it is prudent to allow some degree of autonomy to the employee, there is still the need for overall control so as to have unity of purpose. Economists agree that financial systems need to have control bias otherwise they would not function.
Generally, most managers develop a course of instruction upon which they evaluate the individuals who have followed through and those who have not. This kind of performance measurement also provides the manager with beneficial information about the behaviour of certain employees. This would be necessary when putting in motivational measures or when laying off workers.
Budgeting is the third reason why there is a need for performance measurement. Though they may be ‘crude’ tools as Behn states, they can assist in providing useful performance information.
While cutting costs is usually thought to be the mainstay of many organizations sometimes budgets can be useful to know where to inject more money. However, to make such a decision, there is need for prior information on the demands and output of the particular department.
Behn (2003) finds that on a macro-level, decision makers usually supply a lump sum amount depending on budgetary needs. However, the lump sum amount has to be divided across smaller micro-levels depending on the need and cost effectiveness. However, before the sum is released, there must be an account of previous spending and efficiency so as to determine which units need what amount.
Another reason why performance measurement is important is the need to keep employees motivated. When persons are given particular goals and are then assessed based on their performance, it becomes easier to establish where motivation is needed. However, Behn (20030 states that performance measuring is in itself motivation enough.
The fact that employees are provided with set instructions or targets means that they are kept ‘on their toes’ and when they succeed, the feeling of accomplishment is motivating. Through targets, workers are encouraged to be creative since what the managers need is output not ways of achieving targets.
Celebration is an equally important reason for organizations to measure performance. Again, there is the need for a sense of accomplishment to keep the organization moving forward. Celebration binds the staff of the organization together since it fosters the feeling of individual and collective relevance. It also introduces a sense of self accomplishment and self worth necessary to keep employees committed to the organization.
Promotion is the sixth reason why performance measurement is necessary. The stature of an organization is improved where it measures its achievements and presents them to the relevant public which might be shareholders, legislators or just the general public.
Performance information validates the organization’s success, justifies the need for better treatment e.g. additional resources, earns the loyalty of the staff, customers and shareholders and also wins the organization recognition on a wide scale.
One other reason why it is necessary to measure performance is the need to learn. When managers analyse processes and information provided by performance indicators, they are able to learn the reasons why there is good or poor performance.
However, Behn (2003) insists that organizations must be able to lower the number of performance measures or indicators if the managers are to learn effectively. This is due to the lack of time, confusion over conflicting data and difficulties in sifting through complex and bulky data in the search of ‘good signals’.
Another issue that Behn points out that may inhibit learning is the “black box phenomenon” that characterizes performance measurements. While it is possible to evaluate the input and output of an organization, it does not provide reasons as to why the data appears the way it is. In short, there is no information on what factors are interacting to produce the final output.
As an answer to this, organizations should adopt benchmarking which is a classic form of performance measurement that is able to identify causes and solutions to certain issues plaguing the organization. This way, managers are able to learn and identify the core processes that are intrinsic to the organization.
Good performance measures that can lead managers to learn more about the organizational functioning should always reveal deviations and irregularities from the data results. There is also need to know what to measure and when to measure it. Behn (2003) adds that organizations need to learn from failure instead of hiding it.
The general and overall result of all the above information is the improvement of the organization. Behn (2003) lists this as the last importance of performance measurement. He states that the first step in performance improvement is always the identification of what needs to be improved and the processes necessary for that to occur.
There is also the need for a feedback mechanism where the corporation can assess how it has complied with its own improvement plans. Behn (2003) insists on improvement measures that give managers an opportunity to learn about the dynamics of the organization.
All in all, performance measurement is essential to the organization. However, the type of measurement indicators should also ensure that they provide a coherent picture of the true state of the organization. The picture should promote understanding of the relationships and processes occurring within the “black box’.
This way, the organization will be able to know how to influence or control its employees as well as influencing the opinions of customers, shareholders and the general public. This can be achieved by posturing these measures in a way that managers can relate their actions to the overall impact on the organization’s immediate environment i.e. its operations and workforce.
After all information is in hand, the managers can then take improvement measures based on the results obtained from performance information. In Behn’s (2003) words, the managers can then watch how their actions “ripple through the black box.”
Atrill, P. & McLaney, E. (2003). Accounting and Finance for Non-Specialists. New York: Prentice Hall
Behn, R.D. (2003). Why measure Performance? Different Purposes Require Different Measures. Public Administration Review, 4(2), pp. 56-59.
Kravchuk, R.S. & Schack, R.W. (1996). Designing effective performance-measurement systems under the Government Performance and Results Act of 1993. Public Administration Review, 56(4), pp.348-358.