“It’s clearly a budget. It’s got a lot of numbers in it” (George W. Busch 2005). This definition of a budget can be supplemented using the Oxford dictionary, which states that a budget is an estimate of income and expenditures for a set period of time. Nowadays almost every business uses budgets and managers use them as a tool in order to set targets. In other words managers can, with the use of budgets, explain in a financial way what are the objectives of the business for a period of time, usually one year. Budgetary control is described as the process of planning, controlling and coordinating through money values and departments within an organisation (Buckley and McKenna 1972), and has recently taken a greater importance in performance management. In parallel, the relation between the corporation and the capital market has kept increasing, bringing to light many problems. This essay will then define and explain the benefits of budgetary control as well as its limits regarding the capital market. Eventually, it will attempt to find a solution to those problems.
A budget in an agreed plan of action used to provide direction and co-ordination, giving more structure to an organisation as well as motivating staff to achieve objectives. Performance management is described as “the process of quantifying the efficiency and effectiveness of an action” (Neely, Kennerley and Adams, 1995). To achieve performances, managers have to be in control. There are two types of control, namely budgetary and financial. According to Hofstede, budgetary control is planning translated into money terms (1968). Its process consists for the managers to set up agreed performance standards, and they then control the attainment of those standards. The effects of budgetary control on performance management are simple: a higher budget creates a unit that is expected to produce higher profits. The budgeting cycle describes how budget can be used to provide a basis for evaluation and so to judge performances. Budgeting cycle
At the end of each budgeted period, managers compare actual and budgeted results in order to obtain variances. It helps to control activities by measuring progress against the original plan, making adjustments where necessary. Sometimes a sensible deviation from the initial plan can lead to a set of important actions undertaken by managers in order to restructure the company. It can also provide a basis for revision of the objectives and thus of the strategy. One of the greatest advantages of using budgetary control is that is forces management to look ahead. Indeed ideally it sets out detailed plans for achieving the targets for each department, and so managers anticipate and give the business purpose and direction. Oatley in 2001 notes that nowadays most business enterprises use the assumption that budgetary system has become the more integrative control method. Indeed he assumes that any target fixed by a company can be represented financially by the budget. Thus the budget can be used as a controlling method for most of the issues of the business plan. This theory then demonstrates that the budget can be linked to the overall achievement of any company’s target. Nevertheless, whilst budgets are seen as essential part of any corporation they do have a number of disadvantages. Thus if the target fixed by managers in too hard to reach, an inverse relation can be observed regarding performance: The effect of budget difficulty on performance (Oatley, 1997)
Conflicts within the business can also happen between different departments if the target in not reached or if the budgeted variance is negative....