BUDGETING AS A MANAGEMENT TOOL FOR EFFECTIVE DECISION MAKING

  

 

   CHAPTER TWO

LITERATURE REVIEW

2.0              INTRODUCTION

It is well recognized that an organization should be managed effectively and efficiently. Managing, in fact, implies decision making, coordination and control of the total enterprise efforts to achieve the organizational objectives. The functions of management must include decision making using various managerial techniques procedures and by utilizing the individual and group effort in a coordinated and rational ways. Organizations have limited resources and these limited resources impose limit on the number and range of goals that the organization can hope to attain. One systematic approach for attaining effective management performance is budgeting. Budgeting is an integral part of management.

According to Pandey (2008), states that organizational goals includes maximizing profits and achieving satisfactory level of performance and performing a social service by providing goods and services desired by others. It is with a view of achieving their organizational goals that great emphasis is placed on budgeting. Budgeting therefore is essentially a management tool for effective decision making in allocating scare resources.

2.1              THEORETICAL FRAMEWORK

Ezeamama (2010) opines that growing complexity of the business environment and the ever increasing competition among firms in the modern time make effective decision making an invaluable tool for business success.

Successful management is no longer just a matter of flairs skills and determination- a conscious effort is needed to harness available resources towards the achievement of enterprise objectives. He says that budgeting is one of the tools adopted by management for effective decision making.

Nwadighota (2005) defines budget as a plan expressed in quantitative and usually monetary terms over a specific period of time. Normally the period covered is one year and this makes it a short term plan. Practically all large organization both in the private and public sectors prepare annual budgets. He is of the view that budget is a short term financial plan which guides manager in making decision to achieve the objectives of a firm.

Ama (2003) argues that budget is a quantitative expression of a plan of action prepared in advance of the period to which it relates. Budgeting may be prepared for the business as a whole, for department, for functions such as sales production or for financial and resources items such as cash, capital expenditure, manpower, purchase etc.

Adams (2009) is of the view that budget is a future plan of action for the whole organization or section thereof. It is a systematic and formalized process for purposely directing and controlling future operations towards desired objective for periods extending beyond one year.

Adeniyi (2008) agrees that budget is a plan quantified in monetary terms, prepared and approved prior to a define period of time usually showing planned income to be generated and or expenditure to be incurred during that period and the capital to be employed to attain a given objective.

From the above definition of budget, one can deduce that the purpose of business decision making is to minimize uncertainty about the future and as a planning is therefore required at all levels of an organization sectional and or departmental plan must happen at the same time in order to achieve the objectives of the organization

Osisioma(2000) agree that decision making is the regulation of activities within an organization so that performance are in accord with the expectation established in policies, plan and target.

2.2 TYPOLOGY OF BUDGETING FOR EFFECTIVE DECISION

The commonly widely used types of budgets are fixed and flexible budgets. However, some organization uses continuous budgeting.

Lucy(2004) opines that fixed budget is a budget which is designed to remain unchanged irrespective of the volume of output or outcome or turnover attained i.e. it is a single budget with no analysis of cost, on the other hand a flexible budget is a budget which is designed to adjust the permitted cost levels to suit the level of activity. The process by which this is done is by analyzing costs into their fixed and variable elements so that the budget may be fixed according to the actual activity.  The major purpose of a fixed budget is at the planning stage when it serves to define the board objectives of the organization.

Features Of Budgets

Budgets are prepared by the management in every organization. Large and medium scale business has a comprehensive system of budgeting. A comprehensive budgeting system consists of the preparation of master with a complete package of the components. The features are:

a.                  It is a comprehensive and coordinated plan of action.

b.                  It is prepared prior on a defined period

c.                  It is expressed in financial term or quantitative term or both.

d.                 It is a future plan for defined period which enables decision making.

e.                  It states performance expectation over a defined period of time.

f.                   It integrates the resources and cost of an organization.

g.                  It is aimed at attaining organization objectives.

Types Of Budget

1. Operating Budgeting: Godwin (2001) is of the view that operating budget is a major part of master budget that focuses on the income statement and its supporting schedule.

He opines that income statements are of two parts. A programme of activity budget and a responsibility budget. These represent various ways of looking at the operation of an organization.

2.      Financial Budgets: Collins (2009) explains that financial budget consists of the budgeted capital expenditure - the cash budget, the balance sheet and statement of changes in financial position. That is to say that financial budget is concerned with financial implications of the operating budgets that is, the expected cash inflows and cash out flow.

3.      Capital Budgets: Capital budget is the planning of capital expenditure which normally undertakes a long term basis and is prepared for several years in advance. Capital budget is in respect of such thing like the replacement or increase in plant and machinery, building, acquisition of existing business etc. they involve the plan to acquire worthwhile projects together with turning of the estimated costs and flows of each project. Such project require large sum of money and have long term implications for the firm. Capital budget are very difficult to prepare because estimates of cash frowns over a long term have to be made and they involve a great deals of risks and uncertainty.

     Isyaka and Kazeem (2014) states other budgets; Master Budgets, Materials and Utilities budget, Revenue and Expenses Budgets, Sales Budget, Production Budget, Balance Sheet etc..

The Advantages Of Budgeting

1. The strategic planning carried out by the board of directors or owners can be more easily linked to the decision by managers as to know the resources of the business which will be used to try to achieve the objective of the business. The strategic planning has to be converted into action and budgeting provides the ideal place where such planning can be change into financial terms.

2.      The budgets for a firm cannot be set in isolation. This means that the situation of the business, the nature of its products and its workforce etc, must be seen against the economic background of the country.

3.      The expression of plan in comparable financial terms. Some managers think mainly in terms of, say, units of production, or often of inputs or output, or lorry mileage, etc.

Objectives of budgeting:

1.  State Of Expectation:

Budgeting directs individual and group efforts and operations towards common goals. It establishes a harmony between short-run and long run goals of the firms.

2.  Communication of expectation:

Top management should communicate expectations to all concerned so that they are understood, supported and implemented.

3.  Planning:

Planning reduced uncertainty and provides direction to the employees by determining the course of action in advance. It compels management to plan comprehensively and coherently. It provides an orderly way to proceed to attain goals.

4.      Coordinating: Coordinating implies striking balance labour materials and other resources so that goals of the firm are attend at a minimum lost.

5.      Means Of Control: A budget indicates the performance expected of employees. A budget may therefore serves as an index for measuring employees’ performance. The actual performance of the employee is compared with the budgeted performance.

2.3.      FUNDAMENTALS OF BUDGETING

An organizational structure is a process of dividing work into the convenient task or duties. Such duties is in form of posts - delegating authority to each post and appointing qualified staff to responsibility.

The primary responsibility of the staff organization is to assist line executive in preparing budget by providing data, technical advice and co-coordinating the budget of various department to form a master budget.

Preparation Of Budgets

Lucy(2002) argues that budget are based on plans considering external inherences such as share, technology economic and political changes.

The annual budgeting process in most business is therefore important and serves some purposes. As a management process, budgeting is seen as been closely related to operation of the organization.  The preparation of budget requires the effort of all executives.  Budget encompasses the following:

1.      Sales Budget: This is starting point of budget. Sales budget is significant - it is an estimate of revenue to be generated by the company from its operation as well as the focus of much that is done within a company. 

2.    Purchasing Budget: The purchase of direct material is dependence on the levels of the beginning inventories and the desire ending inventories.

3. Direct Labour Budget: This budget is responsible for the estimate of direct labour costs. This is because indirect costs are included in the manufacturing altered costs budget. The direct labour to be spent on production is a function of the unit to be produced and the labour hours required for production.

4.             Cash Budget:  Osisioma (2000) opines that cash budget represent the cash receipts and payments and the estimates cash balanced for each in flows and out flows over the budget periods.

5.                  The Master Budget: Osisioma (2000) emphasis that budget is a coordinating instrument and a summary of all the financial budget of an organization in corporation.  It represents a consolidation of all the supporting budgets and financial effect of the total plans for the business. The master budget is actually a combination of the budget income statement and balance sheet.

2.4       ZERO-BASED BUDGETING (Z.B.B)

Zero  Based  Budgeting  according  to  the  institute  of  cost  and Management  accountant is a method of budgeting whereby all activities are re-evaluated each time a budget is formulated.

Each functions budget state with the assumption that the fractions does not exist and is at zero cost. Increments of the cost are compared with increments of benefits for a given budgeted cost.  It is a cost benefits approach whereby it is assumed that the allowance for an item is zero and will remain so until the manager responsible justifies the existence of the cost item and the benefits the expenditures bring. Using this method, a questioning altitude is developed whereby each cost item and its level has to be justified in revelation to the way it help to meet objectives and how the expenditure benefits the organization. This technique of budgeting was

introduced in the early 70’s.

Zero based budgeting provides a total approach to budgeting by appraising each functions or activity from the beginning. Thus every item of budgeted expenditure must be examined critically and justified.

ADVANTAGES OF ZERO BASED BUDGETING

a. Properly carried out, it should result in a more efficient allocation of resources.

2. ZBB focus attention on value of money and make explicit the relationship between the input of resources and the output of benefits.

c.  It develops a questioning attitude and makes it easier to identify in efficient absolute or less cost effective operations.

4. The ZBB process leads to greater staff management knowledge of the operations and activities of the organization and can increase motivation.

e.  It is a systematic way of challenging the status quo and obliges the organization to examine alternatives and existing cost behavior Patten and expenditure levels.

DISADVANTAGES OF ZERO BASED BUDGETING

a. It is a time consuming process which can generate volume of paper work especially for the decision packages.

2. There is considerable management skill required in both drawing up decision packages and for the ranking process.

c.    It may encourage the wrong impression that all decision have to be made in the budget. Circumstances change and new opportunities and threats can rise at any time and organization must be flexible enough to deal rapidly with these circumstances.

4. ZBB is not always acceptable to management and staff or trade union who may prefer the cost status quo and who sees the details of  

alternatives costs and benefits as a threat not a challenge.

e. There are considerable problems in ranking packages and there are inevitably many subjective judgment policies pressure within organization also contributes to the problem of ranking different types of activities especially where there are qualitative rather than quantitative benefits.

f. It may emphasis short term benefits to the detriment of longer term ones, which in the end may be more important.

IMPLEMENTATION OF ZERO BASED BUDGETING (ZBB)

According to Nwadighoha (2005), the overall process of implementing Zero Based Budgeting (ZBB) can be divided into three stages, thus;

a. DEFINITION OF DECISION PACKAGES:

A decision package is a comprehensive description of a fraction which can be individually achieved.

The decision package is specified by the managers concerned and must detail the anticipated costs and results expected - express in terms at accomplishment and benefits achieved packages are of two types:

i.             Mutually: Exclusive Decision packages which are alternative forms of activity task and expenditure to carry out the same job where the best opinion among them is so elected.

ii.              Incremental: Decision Packages shows the different level of executing a particular activity with the minimum feasible level of activity known as the base package and other ;packages which describe higher activity levels at given costs and resulting benefits.

b.      EVALUATING AND RANKING OF PACKAGES

When the decision packages have been prepared management will then rank all the packages in the basis of their benefits for the organization. This is a process of allocating scarce resources between different activities some of which already exist and others that are new.

c. RESOURCES ARE ALLOCATED

When the overall budgeted expenditure is divided upon the packages would be accepted. In the ranked priority sequence up to the agreed expenditure level.

2.5       PLANNING PROGRAMMING BUDGETING SYSTEM (PPBS) Nwadighoha (2005) emphasized that programmes budgeting applied the accounting system or the objectives of the nonprofit organization according to activities to be undertaken. The authors were of the view that programme budgets would include estimates of total cash for particular programmers and functions regardless of the organization department(s) involved and without reference to the time period overall by a programme, for instance a local government council embarking on mass immunization of children will make provision for vehicles, medicines and technical staff rather the salaries and wages and other objects of the expenditure. Programme budgeting contributes to better in non-profit organization in two ways:

Firstly, it forced management to identify the activities, functions or programmer to be provided.

Secondly, it provides information by which management can assess the effectiveness of its plans.

Planning programming Budgeting System (PPBS) may be described as a comprehensive planning and budgeting system with the following characteristics.

a. The integration are budgetary process into the planning process

b.  Planning and budgeting for more than one budget period.

c. Planning and budgeting within a frame work which seeks socially determine goals and

d.  Continuous updating overtime of planning and budgeting.

PPBS is designed to avoid the disadvantages of conventional governmental budgeting. Them involves “planninlong term evaluation as opposed to the short.

Run consideration of convictional budgeting. The programming aspect of PPBS involves structuring the budget in terms of goals (programme). The integral components of PPBS involves:

1. Setting of specific objectives

2. Systematic analysis to certify objectives and to assess alternative ways of meeting them.

3. The framing of budgetary proposals in terms of programmes directed towards the achievements of the objectives.

4. The projection of the costs of these programmes for a number of years in the future.

5. The formulation of plans of achievements on yearly basis for each programme, and

F.      An information system for each programme to supply data for the monitoring of achievements of programme goals and for the reassessment of the programme objective as well as the appropriateness of the programme itself.It has certain essential feature.

First, the budget proposal must be classified in terms of function, programme and activity. A function is taken as a board grouping of operations directed towards the accomplishment of a major purpose of government. A programme refers to a board category with a function, which is identifiable with a particular purpose and /or end product. An activity is a segment of a programme, which comes not similar types of work or has similar purposes or achieve similar end-product example a work package.

Second, there must be a detailed description of all activities. To permit the measurement of work done or output produced by each activity.

Thirdly, the budget must be expressed in a way, which allows a direct comparison between cost of funding and work to be performed for each programme or activity.

Fourthly, there must be multi year costing which also permits the preparation of a multi year financial plan.

Fifth, there must be a quantitative education of outcomes to facilitate the monitoring of actual against budget cost and performance.

The outcomes are outputs and three types: workload, intermediate output, and financial output.

Finally, the accounting and reporting structures need to provide information on the linkage between programmes and activities and major policy objectives.

2.6 EMPIRICAL STUDIES

The institute of cost management accountant defined budgeting as the establishment of budget relating to the responsibilities of executive to the requirement of a policy.  The two basic functions of budgeting deals with comparison of actual results with the budgeted data, evaluation for difference and the taking of corrective action and decision to adjust for difference when necessary. The comparison of budget and actual data could occur only after actual accounting data have been accumulated.

Budgeting is a process of management which shows an appraised of presented situation and the immediate past, an assessment of the influence of outsider factor. Example; political or economics and the necessary for moving into new fields. For instance, products are brought together in determining policy.

Omolehinwa (2004) sees budgeting as a tool for decision making in controlling all aspect of producing and or selling commodities or services. Preplanning is a cardinal facture of budgeting control and that each budget has the action of the people, their performance and the cost they incur.

Budgeting, from the perspective of management or exception stated that budgeting is a tool which enable management to consider only items that do not go according to plan and to concentrate on exceptions.

However, Godwin (2001) sees budgeting as a system which uses budgets as a means of planning and controlling all aspect of producing and/or selling commodities or services. Preplanning is a cordial facture of budgeting. The plan is represented in the master budget. Each segment of the master budget is covered by a functional budget.

However, he presented what is considered as landmark in budgeting analysis as it relates to Nigeria.  He stressed on the relationship between accounting and budgeting - he was of the view that accounting system and budget are built around the organization structure and both are information system concerned with the same operation.  The budgeting process helps to organize and formulate the planning and decision required for these operations.

Emeka (2009) emphasized on the importance of budgets and noted that the assessment of budget is only one of phrase of comprehensive system of budgeting.

The use of budgeting provides a co-ordination factor in business. Its importance as a tool of management for effective decision making can be deduced from the foregoing discussion.

It could be seen that it is as significant in planning as it is in decision making. Here actual performance is compared with budget outcome and favorable or unfavorable variance determined. The cause of this variance are sought out and checked thus enabling management to plan and decide future operations.

Ama (2003) explains budgeting as a for a tool for planning and decision making - as the yard stick for the measuring actual performance with that budgeted through the analysis of variance. For budgeting process to be effective the participation of top management is not only required but the true participation, co-operation and understanding of the middle and tower management is also comparative.

2.7   BUDGETARY DECISION-MAKING

Decision Making: it describes the process through which a course of action is selected as a solution to a specific problem.

George P. Hubber-choice making from problem solving.

According to him choice making refers to the narrow set of alternative option. Therefore choice making is a part of decision making.

Problem solving refers to the board set of activities involved in finding and implementing a course of action to correct an unsatisfactory situation. However, P. Drucker makes it clear that opportunities rather than problems are the key to organization and managerial success.

Decision making through systematic budgeting process enables the management to exploit opportunities for reduced cost of production, increased human contribution, increased sales and market share and improved quality products.

This budgetary decision-making process required the manager to balance and harmonize major functions of the business enterprises. It must essentially be a rational process and since the effectiveness of management decision depends on the understanding and voluntary efforts of others, the approach to budgeting will be more responsible and based on knowledge and strategies available to the business.

In addition, a good budgetary system enables the management of the business to develop a system of planning and controlling and it enables proper decision around areas of responsibilities.

The individual responsible managers are encouraged to plan, control and take decisions in turn for the performance of their sub-units towards the achievement of corporate objectives.

When planning and controlling procedures for decision-making are properly streamlined, budgeting then becomes a management tool for coordinating the activities of the business enterprise. It enables interaction between managers and subordinates especially during the budget development activities, which the organizational member will perfor

In summary, budgeting is not mechanical or technical procedure, but a human and objective element of management, its success is actually dependent on the goodwill and co-operation of the participants. Without this, budgeting will become a paper exercise with no real impact on operations of the organization except perhaps negatively.