Budgeting is a planning function in which organization’s financial and operational goals are set. So budget is a blueprint and an action plan for the future. The utility of the budget is in allocating resources, formulating plans and evaluating performance. Many businesses prepare budget annually by the use of historic data. Mostly the previous year’s data are used with appropriate projection model to forecast data for the next one, two or even more years. The basic task in budgeting involves listing the firm’s fixed and variable cost and then allocating resources accordingly (Hope 2003)
Budget is also an estimate of the revenues and expenditure of an entity within a specific time period. It is the projection into the future and estimates how much expenditure is legitimate and how much will be financed by the incoming revenues. It also lists the ways of how the gap between revenues and expenditures be financed. It also states the effect of financial decisions on the financial position and statements of the firm. Budgeting is a very comprehensive process and involves many tasks and functions (Hope 2003).
Performance management is the process in which it is ensured that the goals set in the budget are consistently being met in an efficient and effective manner. Performance management can be used to gauge the performance of any entity whether whole organization, single department, production process or employees (Bacal 1998).
Performance management is a whole set of system in which best practices are defined for a firm and its individual department. Research has identified several areas which affects the organization’s performance. These are sales, finance, product development, operations, human resource, IT/systems, customer service and marketing. These areas are under the control of the management and performance management is used to ensure that these areas work in line to meet the overall corporate objectives and goals. Performance management system involves integration of information reporting and analysis, planning, measuring and monitoring tasks throughout the organization. This creates a synergy which helps in meeting the performance standards set for the organization and its individual department (Bacal 1998).
Performance measurement is a component of performance management. It is basically the parameters which measure the progress of programs, investments and acquisitions as they reach towards completion. The process of measuring performance extensively uses the mathematics and statistical tools to determine the extent a specific organizational goals are met. Performance measurement helps much in managing the performance of an organization, department or single employee because it provides concrete evidence in numbers about the progress of that entity. It tells where one is lacking in performance and is helpful in giving him feedback and suggesting the corrective actions (Bacal 1998).
Performance measurement can be used in absolute terms or it can be relative, in other words, performance measurement can be used to set benchmarks. Industrial averages and competitor’s performance data are good starting point to measure and then compare our performance with them. Thus comparing our performance measurement with that of competitor’s clearly demonstrate our relative position and gives us the signal to either improve the performance or set higher standards. Performance measurement helps answer following questions (Bacal 1998).
- Where to improve?
- Where to allocate or reallocate people, money and resources?
- How you are doing in comparison with others?
- Whether our performance is improving or declining?
- Which programs, employees and processes are producing the desired result and are cost efficient and effective?
Evaluating the Use of Budget
Budget is the starting point for every action in the organization. Management heavily relies on budgeting process to set future goals and plans. Budget determines the appropriate behaviours for employees as well as managers. Budget helps in determining the extent to which corporate goals are being met. As the new fiscal year starts, the previous year’s data are projected to create performance standards for the following year. The success of managers lies to the extent the actual figures match or exceeds the budgeted ones (Hope 2003).
However today business environment is very dynamic and things are changing constantly. This era calls for flexibility in the organization culture in order to timely adapt to changing market and consumer preferences. Hence fixed budgets are not useful today. They are static instrument and makes management believe that what was best last year will also be suitable in the following one. In this global era with diverse demographics and lifestyle of customers and agile competitors, organizations should be prepared to constantly review their priorities, programs and processes and promptly shift resources from one product to another in order to satisfy the potential customers and add value to the shareholders(Hope 2003).
There are certain limitations of traditional budgets. The first is that the budget tries to oversimplify the facts and ignores the challenges of the real world situation. It does not consider the problems faced by the managers in handling such factors as labour market, economy, impact of the competition and social changes (Hope2003).
The second limitation is that budget stresses on achieving the end result and does not consider the reasons of failing to achieve those results. That is budget provides a good comparison between actual and budgeted amount of net income but it will not explain the reason if any discrepancy occurs. If the costs of raw materials were high, the budget will show poor performance, however the costs were high due to overall increase in prices of goods in the economy (Hope 2003).
Thirdly, the budget demands high level of management support and involvement. If management is not convinced of the benefits of budgets and is distrustful of its importance in improving the company’s performance, then the budget loses it value and utility. The budgeting process will only be a formality and it will do nothing in guiding the behaviour of employees and allocating the right amount of resources. Hence budgets are mainly dependent on management’s approval (Hope 2003).
Fourth, the budgets often undermine the initiative and creativity in organizational culture. Managers and employees often fear making new development or taking actions which are not covered or specified in the budget. Hence budget promotes mechanical culture and deprives the firm of the flexibility required to meet the challenges of the dynamic environment (Hope 2003).
Fifth, budgets also often work against the overall corporate strategy. If the department head is given a specific spending budget for the year, he may take actions which will affect the corporate goals. For example, manager of the production department is going out of the budgeted cash expenditure. He may decide to postpone the necessary preventive maintenance of the machinery in order to contain the expenditure within budgeted limits. In the short run, he is able to meet his budget targets, but in the long run it is harming the productivity of the machinery and hence the overall corporate goals. Therefore a budget is very short sighted and does not consider the long run effects of certain action. (Hope 2003).
Finally the budgeting is not the perfect science. It is a very subjective process and is prone to errors. It is usually developed on the best information available and requires frequent revisions as new facts are known (Hope 2003).
Budgeting in a Service Organization
Since this paper talks about the use of budgeting in university and because it is a service oriented firm we will provide some background on this sector of the economy. Budgeting is also an integral part of service firm but because it does not have inventory, the focus of budgeting in this sector is different from the traditional one. The most important part of service firm is labour because they are mainly involved in generating revenue for the firm.
Therefore service firm are labour intensive. Service firm also has focus on customization and hence labour has diverse skills as they involve in various non repetitive tasks because each one have different job requirements. Thus it is very difficult for the firm to predict what type of services will be performed by its labour and hence the process of projecting costs and revenues get complicated (Otley 1978).
The service firms go for maximizing the revenues and therefore their primary financial concern is to keep its professional staff busy most of the time. Hence the labour budget is the most important budget in service firm and its purpose is to match the labour requirement adequately with the demand of services so that no labour is idle for long. The labour cost subsequently determines the fees to be charged for providing the service; therefore the accuracy in forecasting the labour requirements is crucial in meeting the financial goals of the firm (Otley 1978).
While manufacturing firm uses top down approach of budgeting, service firm is said to use the bottom up approach. In manufacturing concern, the budgeting process starts from estimating the future sales and then determining the resources needed to achieve the projected sales level. Hence the estimate of the revenues tells us the cost of the resources needed in the budgeting period (Oliva 1992).
On contrary, in service firms, the cost of the labour is the starting point for determing the revenue level of the future period, hence the bottom up approach. For the specified period, the professional staffs are kept fixed and therefore it is a fixed cost and indicates the capacity of the firm. The purpose of the firm is to optimally utilize this capacity to generate that much amount of revenue which can cover this fixed cost plus earn the expected amount of profit. Hence these are the primary issues, concerns and difference of the service oriented firm regarding the budgeting process (Stone 1999).
Assessment of University’s Budgeting Process
The budget of the university is massive. In the fall of each academic year, the budget planning starts for the next coming academic year. Every year the dean of various schools of University and vice presidents of executive offices start the tedious work of formulating budgeting estimates for their assigned units and departments. Each year, deans and vice presidents are guided to maintain the lowest possible cost estimate as possible for their units. Just one or two percent cut in cost is very appreciable because it makes a great difference in total. But equally important, the cost cutting should not impact the quality of life students experience at the campus (Souza 2001).
Moreover each unit of the university set priorities for itself. Then in budget it has to reallocate resource, one or two percent, from the low priority to the high ones. Once this basic work is done each unit compiles its budget recommendations and then forwards it to the main office of the dean. Then at the annual budget conference, each unit’s budget is reviewed and discussed and amendments are made as required to meet the overall objective of the university (Franklin 2005).
The budget conference starts from January every year and stretch over three months till March. The meeting is the good place for the deans and executives to present their case and justify the amount of money they are demanding. Recently a new trend has started in which vice president for student affairs is also invited with his proposal to check and allocate the adequate amount of resources for student’s requirements (Franklin 2005).
Every unit of the university is asked to specify the specific activities on which the money will be spent. The notion of lump sum payment is abolished so that it can be checked where the money is going. Even the system of taking the previous year figures and then projecting it and adjusting for the inflation and then passing it as the next year budget is also abolished. If a unit is not able to justify its use of resources satisfactorily then its requisitioned amount will be rejected outright (Rodriguez 2003).
Then after the budget conference, there is a separate meeting of the budget team who discusses each school’s priorities for the next year and those activities which seem unimportant and redundant are eliminated for the purpose of cost containment. A large saving of money is possible in the way University orders and distributes supplies, if energy and power is used efficiently at different campuses and schools and effective strategies of employee health care benefits are developed(Rodriguez 2003).
The university also deals with similar conservative approach with the money it receives from federal stimulus package. University has made two advisory bodies “Student Budget Advisory Committee” which consist of students on the campuses and “Prudence Panel” which include the faculty and staff members. These groups serve the purpose of advising the budget team in developing the final budget. Thus the budget making process is very participative and listen the voice of every interest group (Risher 2003).
Finally after all the recommendations and research proposals are received and discussed by the budget committee, the dean of university with his staff will give the final shape and approval of the year’s budget in which the expenses is expected to be balanced by the revenues. The main sources of revenue for the university are tuition fees paid by students, appropriation from the state, endowment revenue, research grants and charges for providing miscellaneous services (Nielsen 2008).
The university selects the activities and events for the next year on priority basis and which add more value for the student and staff. However the money allocated to these activities are estimated very conservatively for containing cost. Some years the estimated figures turns out to be incorrect and the difference between the actual and budgeted has to be absorbed internally. But conservation is a good strategy because it keeps the tuition fees at reasonable level and keeps it from changing drastically.
Each year estimating the funds from the state is very difficult as economy gets uncertain. Therefore university has to be very careful in getting overly optimistic. However, university has maintained a very best practice of taking into account every stake holder’s concerns while formulating the budget.
Bacal, R. (1998). Performance Management. McGraw-Hill.
Franklin, A. L. (2005).Are we All Touching the Same Camel? Exploring a Model of Participation in Budgeting. The American Review of Public Administration. 35, 168-185.
Hope, J. (2003). Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap. Harvard Business School Press.
Nielsen, S. B. (2008).Improving Performance? Exploring the Complementarities between Evaluation and Performance Management. Evaluation. 14, 171-192.
Oliva, T. A. (1992).A Catastrophe Model for Developing Service Satisfaction Strategies. The Journal of Marketing. 56, 83-95.
Otley, D. T. (1978).Budget Use and Managerial Performance. Journal of Accounting Research. 16, 122-149.
Risher, H. (2003).Refocusing Performance Management for High Performance. Compensation & Benefits Review. 35, 20-30.
Rodriguez, A. (2003).Performance Measurement, Strategic Planning, and Performance-Based Budgeting in Illinois Local and Regional Public Airports. Public Works Management & Policy. 8, 132-145.
Souza, C. (2001).Participatory budgeting in Brazilian cities: limits and possibilities in building democratic institutions. Environment and Urbanization. 13, 159-184.
Stone, M. M. (1999).Research on Strategic Management in Non-profit Organizations. Administration & Society. 31, 378-423.