Importance Of Budget Preparation For Business Growth: Traditional Vs Alternative Budgeting Systems

The process of budget preparation

The present report is developed to provide an adequate understanding of the process of budget preparation and its significance for promoting the growth and development of a business entity. The budget preparation enables to develop an expenditure plan that helps in gaining an estimate of the future needs of the business so that it can implement adequate strategies for meeting them properly. The report has specifically discussed the case of TownScape Plc that is regarded as an international manufacturer of street furniture. As analyzed from the case study, the company adopts the use of traditional technique of budget preparation. However at present the company is undergoing significant changes with undertaking new and revised contracts of up to worth £35 million and requires additional plant and manufacturing facility in the year 2018. The finance director of the company is concerned with the inappropriateness of the current budgeting system used by the company to meet its future aims and goals. The most significant problem that the company is facing at present is that the change in the budget approach will become effective from the year 2019. In this context, the report presents the comparison of the traditional budgetary system with the alternative budget methods such as rolling budgets, zero based budgets and activity based budgets. The potential application of these methods to develop the budget more effectively is also analyzed in the report to identify the best possible method for developing the budgets for the company in context (Malina, 2017).

Budgeting can be stated as an important process of business planning by predicting the potential growth prospects of a company. The purpose of budget is to develop a business model that helps in providing an overview of potential growth prospects of a company. The budgeting process enables to forecast the income the expenses and thereby estimating the future profitability position of a company. It helps in development of a financial framework that detail out the overall financial activities for facilitating the decision-making of financial managers. It develops a proposed action plan for planning of future financial needs and also gains an estimate of the future financial risks that can impact its growth and performance (Moles and Kidwekk, 2011).

It helps in making a comparison between the actual business growth against the forecasted performance and thus determining the potential chances of its success. The deviations found in the actual performance as compared to the predicted can help in identification of the loopholes in the business strategy. As such, the business managers can implement specific actions for overcoming the issues identified to ensure the long-term growth and development of the company. The process of budget preparation in the company need to consist of the following steps:

• Stage 1:Development of Budget Policy 
  • The step involves developing the budgeted period, time table and developing the budget committee in order to provide a clear direction to the management for developing the budgets.  The budget is prepared for the period of 12 months and each stage is monitored and evaluated by committee on a regular basis.
• Stage 2: Communicating the Guidelines of Budget to Relevant Managers
  • Budget committee is responsible for disseminating the information obtained from the process to the relevant managers. This is essential to provide understanding to the budget managers about the strategic plan that need to be undertaken for supporting the company’s growth and development (Rasmussen, 2003).
• Stage 3: Identification of the Limiting Factors
  • The stage consists of identification of the significant problems or issues that can negatively impact the company plan of future growth and development.
• Stage 4: Preparation of Budget
  • The identification of the limiting factor is followed by determining the overall impact of the issue identified on the future growth and development of a business entity. This helps in identification of the issues for which the budget forecast need to be done for example, sale budget or any other.
• Stage 5: Developing the draft budgets for all other areas
  • The drafts of other issues that are identified for developing a budget for the limiting factor should be prepared by the management so that it can be developed in the future context on identification of the significant problem or issues.
• Stage 6: Review and Coordinating the Budgets
  • The budget committee needs to monitor the consistency of budgets with one another in order to identify the issue of lack of co-ordination or any that might impact the budget preparation process.
• Stage 7: Developing the Master Budget
  • It is prepared by the budget committee and includes the preparation of budgets such as budgeted income statement or statement of financial position.
• Stage 8: Communicating the Budgets to the Relevant Parties
  • The operating budget prepared is passed to the senior management for review and is also shared across the other departments so that all business managers attain a clear direction of what needs to be achieved (Wickramasinghe and Alawattage, 2007).
• Stage 9: Monitoring the Performance against the Budget Prepared
  • The step involves identification of the variance between the actual performances of the company against the determined targets in the budget prepared.

The significance of budgeting for business planning

Cost driver is responsible for the change in the cost of an activity. An activity consist of more than one cost drivers for example production activity can have cost driver such as machine hours, labour hours, power unit used, output of inventory, etc. In order to identify the cost driver for any business it is important to first identify the cost object that is responsible for triggering the cost in various activities. For example, in case of business that is involved in the regular material handling has to allocate the total material handling cost to different working units and for this purpose there is need of cost driver (Adler, 2013).

TownScape Plc is an international company and it is actively involved in the manufacturing of the street furniture. Some of the important goods manufactured by the company are benches, litter bins, cycle racks, street bollards and bus shelter. So it can be said that there can specific activities that are carried out by the TownScape Plc to convert the raw material into the finished goods. Some of important activities that can be carried out in company which is involved in the wood and steel furniture industry are as follows:

Activities	Cost drivers in each activity
Receiving of the raw material and storage	No. of receipts (receipts/total units), Area used by product (sq ft)
Machining	Machine hours (hours/unit), Direct Labour Hours, No. of production runs (runs/total units)
Assembly	Machine hours (hours/unit), Direct Labour Hours, Number of units assembled
Finishing	Machine hours (hours/unit), Direct Labour Hours, Number of units forwarded to the finished goods
Setup	Number of Setups,
Utilities	Area used by product (sq ft)
Packing	No. of deliveries (deliveries/total units)
Engineering	No. of hours used by the Engineer or fixed cost
Other Cost	Either allocate by machine hours or direct labour hours

(McWatters and Zimmerman, 2015)

Traditional budgeting is the type of budgeting in which last year budget has been taken as base in order to plan out the future budgets. In traditional budgeting incremental approach is applied to incorporate the changes in the existing system such change in sales volume, change in expenses etc. Incremental budgeting does not allow incorporating the changes such as addition of new workplace to cope up with the new contracts. So through use of traditional budgeting technique only changes required in the existing budgeting system can be incorporated in the future budgets preparation but it fails to respond to the changes required to be incorporated by the TownScape (Marco, Te’eni, Albano and Za, 2012).

TownScape is presently adopting the use of traditional budgetary systems for budget creation and presentation. This system involves developing a budget by taking into consideration the budget developed for the past year as a base and adjust it for the inflation and the business changes. It helps in providing an estimate of projected sales and revenue and gain an estimate of the future profitability position. The company at present is planning to undergo significant changes for meeting its contractual obligations and as such the use of traditional budgeting system does not seem to be appropriate in meeting its future business form. This is because it needs an accurate estimation of plant and manufacturing capacity required in the year 2018 for meeting its business needs. However, the traditional budgeting system is not a reliable method for developing accurate estimations as it is often prone to variety if a data entry error as it is developed with the use of spreadsheets.  Also, the budgets prepared with the use of traditional budgeting system are not reviewed regularly and therefore it is not useful for incorporating the recent business changes into account. It is not largely useful for developing a strategic plan as the budget main purpose of creation is cost reduction instead of creating value for the shareholders and therefore it does not help in development of strategic initiatives for meeting the changes proposed in business aims and objectives (McWatters and Zimmerman, 2015).

Identifying cost objects and drivers for budgeting

The finance director of TownScape need to gain an in-depth understanding of the various types of alternative budgeting system and their benefits and drawbacks before selecting the best method for adoption in the company. These can be discussed as follows:

Rolling Budgets

Rolling budget are the budgets that can be updated continually for adding of a new budgeted period.  The budget is subjected to change as per the additional activities to be carried out a business entity in the coming period of time. The budget involves extending the existing budget incrementally as per the changes in the business operations. The budget is based on a rolling estimate against the forecasted changes in the budgeted activities so that it can be expanded in future as per the business requirements (Warren, Reeve and Duchac, 2011).

The budget is extremely advantageous for the companies that have high variances in the economy and commerce. TownScape can gain benefit from this type of budgeting system on account of its flexibility and incorporates the updated information about the forecasted financial performance of the company. It will enable the company to become more responsive in respect of the changes in external environment and also its preparation will not involves nay extra investment of funds or time by the company. However, the most pertinent drawback with the use of such budgeting system is that it can adopt the use of unrealistic assumptions such as revenue forecast that can result in providing large variances (Clowes and Scriven, 2015).

This method of budgeting adopts the use of Zero Base and all the significant expenses are recognized for each new period. It involves the preparation of budget from starting point for each of the line items on the basis of its cost and requirements. Thus, this system of budgeting does not involve extracting any information from the previous year budget is prepared all fresh.

The significant advantage of this method is that it a flexible type of budget and helps in overcoming the issues of budget inflation. The potential drawback is that it is subjected to being manipulated y the managers (Kjerstad, 2003).

This method of budgeting involves developing budgets as per the cost of each activity and then involves a compilation of the overall budgeted expenses. It provides an accurate estimation of the future business expenses and thus improves transparency in the budgeting process. However, it is associated with the drawback of requiring heavy expenditure and large consumption of time for its effective implementation and adoption (Tilanus, 2012).

Traditional budgeting system at TownScape Plc

TownScape Plc at present is incorporating the use of traditional budgeting system. However, the company at present is planning for undertaking some major changes for its future growth and therefore has to adopt some flexibility in its budgeting system to increase its responsiveness for the future changes. As such, the use of alternative method of accounting would help in improving the responsiveness and flexibility in the budgeting system of the company. The rolling budget system can be applied by the company on the basis of expectation of change in the environment. For example, if there is addition of several new product lines each year that requires monthly updates. Therefore, the system of rolling budget can be potentially applied by developing a change management team for determination of how often the business environment is likely to change. The major impact of rolling budget is on planning element of budgeting as it helps in developing a specific plan for meeting the uncertainties in future. For example, the techniques of SWOT analysis, brainstorming and balanced scorecard can help in identifying the external and internal changes that can impact the company performance (Scheller-Kreinsen and Geissler, 2009).

The method of zero based budgeting can be applied by the company by detailed examination of all the previous expenditures to identify the wasteful activities to be removed. It then starts with the use of blank sheet and develops budgets by redesigning the cost structures as per the future business changes. It will have a major impact on redesigning the operations and resources of the company as per the new strategic goals developed. The activity based costing can be applied by identification of the cost drivers that are responsible for incurring revenue and expenses for the company in and its significant multiplication by the activity level. It will have a major impact on the coordination element of budgeting as it involves calculating the overall expenses after determining the cost of each activity (Shim, Siegel and Shim, 2011).

The company at present is recommended to adopt the use of rolling based budgeting system as it will enable the finance director to adjust its budgets as per the future business changes without having large changes in its structure. The finance director can add a future period of estimation in the budget that is of a month, quarter or year. However, the company in addition with his budgeting system is also recommended to adopt activity based costing in the long-term. This is because it will enable the company to implement material changes in its budget system. As such, the method is required as the use of rolling budge system will only simply adjust the previous year budgeted amounts as per the forecasted changes. The cost involved in various activities for adding plant and manufacturing capacity by TownScape Plc can be identified accurately and this will help in gaining an estimate of the overall expenses (T?nase, 2013).

Conclusion

It can be stated from the overall discussion that the budget preparation enables to develop an expenditure plan by the company that helps in gaining an estimate of the future needs of the business so that it can implement adequate strategies for meeting them properly. It has been identified from the overall case analysis that the method of traditional budgeting is not suitable for TownScape. It is recommended to adopt the use of alternative method for improving flexibility in its budgeting system for meeting the future business changes.

References

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