Budget Roles and Functions Affecting the Business Environment

01/05/2020 1 By indiafreenotes

A budget is a financial plan for the future concerning the revenues and costs of a business. However, a budget is about much more than just financial numbers.

Budgetary control is the process by which financial control is exercised within an organization.

Budgets for income/revenue and expenditure are prepared in advance and then compared with actual performance to establish any variances.

Managers are responsible for controllable costs within their budgets and are required to take remedial action if the adverse variances arise and they are considered excessive.

There are many management uses for budgets. For example, budgets are used to:

  • Control income and expenditure (the traditional use)
  • Establish priorities and set targets in numerical terms
  • Provide direction and co-ordination, so that business objectives can be turned into practical reality
  • Assign responsibilities to budget holders (managers) and allocate resources
  • Communicate targets from management to employees
  • Motivate staff
  • Improve efficiency
  • Monitor performance

Whilst there are many uses of budgets, there are a set of guiding principles for good budgetary control in a business.

In an effective budget system:

  • Managerial responsibilities are clearly defined – in particular the responsibility to adhere to their budgets
  • Individual budgets lay down a plan of action
  • Performance is monitored against the budget
  • Corrective action is taken if results differ significantly from the budget
  • Departures from budgets are permitted only after approval from senior management
  • Unaccounted for variances are investigated

Functions of Budget Affecting the Business Environment

The budget is a critical planning tool for an organization. When developing a budget, it is important to be as concrete and specific as possible about future income and expenditure. The budget must consider direct and indirect costs and enable the organization to allocate and plan for the coming year. Budgets are prepared before the start of the fiscal year, so unknown factors need to be predicted. Budget analysts review historical trends as well as make assumptions about upcoming expenses to try and accurately predict the organization’s financial situation for the year ahead.

  1. Revenue

Budget predictions are impacted when actual revenue received is not as much as originally anticipated. External factors negatively affecting assumed revenue might include an economic downturn, unexpected competition causing lowered sales or an inability to sustain the level of growth needed. Internal factors such as inadequate collections and poor accounts receivable practices could also impact revenue. Aggressive projections that assume a high rate of growth or increased revenue have a much greater potential for inaccuracy than conservative estimates based on data from previous years.

  1. Expenditure

Expenditure may be one of the most difficult areas of the budget to predict. Increases to health insurance, turnover levels and collective bargaining in unionized organizations can all change salary and benefits by a significant margin. In many industries, salary and benefits is more than 50 percent of the organization’s total expenses. Any variance to employee compensation will have a noticeable impact on budget predictions. Other unanticipated expenditures may include rent increases, a previously unforeseen need for overtime and financial audit fees and fines.

  1. Market Conditions

The economy and current market conditions can impact the financial forecast in several ways. Changes to the inflation rate and stock market conditions directly affect the organization’s net worth and its ability to generate funds or loans. If the company relies heavily on investments as a funding vehicle, then poor stock market performance will have a direct, negative effect on budget predictions. Likewise, if the rate of return on investments outperforms the prediction, then the budget will have a surplus.

  1. Legislative Changes

Certain legislative changes have a direct impact on budget projections. In most cases, businesses will be aware of pending legislation before it takes effect and can plan accordingly. Sometimes, just the introduction of future legislation, even if it has not taken effect, will disrupt current budget projections. An example of this was the introduction of Governmental Accounting Standards Board (GASB) legislation related to retirement and other postemployment benefits. Although the legislation did not take effect immediately, the impact of the future legislation was clear. It immediately revealed that local governments would have millions of dollars of unfunded liability under some of the proposed rules. Consequently, the organizations’ bond ratings started to take into account the potential liability and some were downgraded as a result, hampering ability to borrow money and directly impacting cash flow. Another example of an immediate legislative change that impacts budget forecasts is a change to taxation.