Business Finance

Part 1

1 Purpose and objective of preparing a budget

Budget is a statement which is used to prepare a projections about the cash inflow and outflow that may takes place in the business. Firms irrespective of their size prepare a budget. Purpose and objective for preparing a budget are given below.

Control on Expenses: The main aim of preparing a budget is to maintain stiff control on the expenses. The main aim of the business firm is to make expenses within the estimated revenue amount (McLean and Zhao, 2014). So that surplus cash balance can be maintained in the business. In the budget projections about the income and expenses are prepared and expenses are made with in the value that is determined in the budget. By doing so elevation in the expenses is controlled by the business firm which enhance cash balance in the business. Thus, it can be assumed that budget have a significant importance for the business firms.

Employee’s Motivation: Emilia need to prepare a budget for its business because budget give multi-dimensional benefits to it. In the budget projections about sales is prepared. Firm prepare a strategy in order to achieve target sale in the business. Under this targets for each and every employee is determined in respect to area in which he is working for the business firm. Achievement of this targets help business firm in achieving its objectives (Hillier, and et.al., 2014). Tough targets are determined for the employees which motivate them to work hard at the workplace. It can be said that budget help business firm in making best use of the workforce.

Making best Utilization of Funds: Most of business firms irrespective of their size face a lots of fund problems. This is evident from the fact that in case of most firms balance sheet debt is identified with big amount in the liability side. To some extent it is difficult for the business firms especially those are of small size to obtain loan from banks and other financial institutions. By preparing a budget allocation of fund that company received from the bank or any other financial institution is made among different expenses (Cheng, Ioannou and Serafeim., 2014). In this way best use of available fund is made by the business firm and maximum return is obtained on same in terms of profitability. This reflects that there is an importance of the budget for the business firm.

Performance Measurement: The main aim of preparing a budget is to measure firm performance. At end of the specific time period, actual figures in respect to the components of the budget are computed and compared with the values that are in the budget. On this basis, performance of the firm is measured. Corrective actions are taken in respect to areas where performance was not up to expected level.

2. Application of traditional budgeting system in the business

Under traditional budgeting system past years figures are taken in to consideration and on that basis budget for the current time period is prepared by the business firm. Incremental budgeting method is used under the traditional budgeting. In this approach percentage increase is done in the values that are in the previous year budget. In order to prepare an incremental budget specific process is followed by the managers of the firm. First of all current year business environment is evaluated deeply. In this regard PESTEL analysis is done by the managers. Thereafter impact that all components of the mentioned analysis may have on the business firm revenue and expenses is identified. For example if turmoil will comes in existence in the UK economy then inflation rate may increase above a certain level which may be dangerous for the business firm. In such kind of situation revenue of the business firm may decline (Bánciová and Raisová, 2012). By doing analysis in such a way percentage change that may take place in the sale and expenses of the business firm in comparison to previous year are identified. Apart from this, while preparing an incremental budget previous year variance that was identified between actual expenses and budgeted one is taken in to consideration. Manager of the business firm make an attempt to identify the reasons due to which such variance comes in existence. There may be two reasons due to which variance comes in existence. Business environment may change at fast pace or firm can make a mistake in making forecast. Apart from this, there is no third reason due to which variance comes in existence. By analysis of identified reason that was responsible for variance firm can ensure that it is determining value for the budget in right way. In order to prepare an incremental budget in the right way managers often analyze previous year business environment and identify the extent to which firm performance deviate from standards. Impact of business environment on firm performance in previous years is analyzed in systematic way (Munteanu, 2012). This help managers in identifying that with change in business environment to what extant change comes in revenue and expenses. Obtained result help managers in ascertaining the percentage change that may be observed in the revenue and expenses if expectation that they have about business environment really happen in future. In this way percentage increase that need to be made in the previous year budget value is determined and incremental budget traditional budgeting system is prepared by the managers. This is the entire approach that is used to prepare an incremental budget for the business firm.

3 Appropriateness of the traditional budget for the business firm

Traditional budgeting system is appropriate for the business firm. Some reasons due to which it is assumed appropriate for the business firm are explained below.

Business will grow in the Future: It is well known fact that every business firm prepare a plan for expansion of the business. Usually, business firm expand its business in other product line. With increase or diversifying business operations expenses of the business also increases. Apart from this, sale revenue of the business also increase. Hence, there is high probability that with passage of time revenue and expenses of the Emilia will increase. In the incremental or traditional budget also past year budget values are increase (Masca, 2012). Thus, it is clear that traditional budget is appropriate for the Emilia.

Enhancement in Inflation Rate: In the domestic economy usually inflation rate get increase or remain at same rate. With elevation in the inflation rate price of the raw materials and products get increased. On other hand, business firms also enhance their product price. Thus, it can be said that with passage of time business firm’s revenue and expenses increased by low or moderate rate (Irwin and Scott, 2010). In case of incremental budget also values of sales and costs are enhanced by the certain percentages. It can be said that in business firms both variables increased on year on year basis. Same thing happened in case of budget. Due to this reason use of traditional budget is appropriate for the business firm.

Enhancement in Production Capacity: Business firms does not stop at specific level in terms of enhancement of the business operations. They consistently increase their production capacity and those firms that are operating in the service sector like Emilia increase their customers serving capability and capacity. Hence, even firm is operating in same product line it is confirm that its sales revenue and cost will increase (Oakshott, 2012). Due to this reason traditional budget system is assumed appropriate for the Emilia. By using this budgeting approach cost and cash inflow values can be projected in better way. Hence, incremental budget is assumed appropriate for the Emilia.

Little Change in the Past and Current Year Economic Environment: It is well known fact that economic environment does not change suddenly. With passage of time changes takes place in the economic environment slowly. Thus, it can be assumed that impact which economic environment have on the business will remain continue. Previous year budget was prepared by considering the economic conditions that prevailed in the current time period. There is a very high possibility that in current time period percentage change that was made in the budget of the previous year in the variables will repeat again in current time period (Bahrammirzaee, 2010). Hence, incremental budget is appropriate for the business firm.

Part 2

4 Alternative budget system

In opposite to the incremental budget system zero based budgeting method is used by the business firms. The approach that is used to prepare a zero based budget is totally different in comparison to the alternative budget system. In the zero based budgeting method previous year projections are not taken in to consideration. Instead, from starting point new budget is prepared by the business firm. Under zero based budgeting method all departments head have to make projections. Means that sale department head will prepare a sales budget under which he will make projections about sales and marketing expenses (Zikmund and et.al., 2013). Apart from this he will need to give justification for the assumptions that he made about components of the sales budget. Same thing other department heads needs to be done from their side. After receiving projections from the all department heads final budget is prepared by the relevant person. Until budget is not received from any department no allocation is made to same. This is the main feature of the zero based budgeting. It is the entire approach that is followed to prepare a budget under zero based budgeting method. It can be said that correct method is followed to prepare a zero based budget. This is because every time it is not necessary that past will repeat itself. Sometimes trends got break and in that situation huge fluctuation comes in the sales and cost of the business firm. In the zero based budgeting method all possibilities are covered and justifications are demanded from the relevant people. This approach ensured that after due consideration of factors and long hours brainstorming appropriate values are determined in the budget which are highly reliable in nature. It can be said that alternative budget system is appropriate for the business firm (Stevenson and Wolfers, 2011). Hence, it can be said that legitimate approach is followed by the business firm to prepare a budget under zero based budgeting method. There is a logic behind determination of each and every value for the budget that is prepared for the business firm. Sometimes different interrelated department’s think the varied directions. Sales department head may think that sales will not increase in the upcoming time period. On other hand, finance manager may think that heavy amount of money will be needed to meet business requirements. In case of such kind of situation relevant managers carry out detail discussion on the assumptions that they made in respect to projections prepared by them. Hence, it can be said that after doing discussion in detail appropriate values for the budget are determined. Such kind of approach enhance reliability of the budget that is prepared by following a zero based budgeting approach.

Apart from zero based budgeting other alternative budgeting system is activity based budget. In the activity based budget activities are identified that play an important role in generating revenue for the business firm (Tirole, 2010). Cost is directly allocated to these activities of the organization. Interrelationship among these tasks are identified and analyzed deeply. Values of the budget are enhanced but only inflation factor is not considered to increase values of the budget in comparison to previous year. Hence, it can be said that after considering multiple factors final value for all components of the budget are determined. This sort of budget is prepared by the firms that are involved in manufacturing goods and services at the workplace. Hence, it can be said that there is an importance of the activity based budgeting (Serghiescu and Văidean, 2014). There are advantages of the activity based budgeting because in preparing same instead of expenses activities cost is taken in to consideration for preparing a budget. The cost of activity based budgeting method is very high. This is because more information and time is needed to prepare activity based budget relative to zero based budgeting and incremental budget.

5 Application of zero based budget and activity based budget for Emilla

Zero based budget is applied in simple way at the workplace. However, one needs to follow a long process in order to prepare a zero based budget. Under this budget method first of all top management give an instruction to the department heads to prepare a projections for their departments. Usually, departmental head evaluate the business operations and on the basis of their estimation prepare projections for the departments. These department heads have to send projection prepared by them to the top managers along with the assumption sheet. Top manager read out entire budget that is prepared by the department heads. Relevant entity try to verify the assumption (Hale and Held, 2011). After passing projections that are prepared by the all department heads same are combined in order to form final budget for all departments. Sometimes if required meeting is organized among the department heads and broad consensus on specific thing is developed among them. In this way if required assumptions that are prepared by the department heads are altered to some extent. This is the entire process by following which zero based budget is prepared for the firm and implemented at ground level.

Advantage

• Reliable values are ascertained for each and every component of the budget (Klapper and Parker, 2011).
• On budget preparation process different level of manager’s work together. All things are cross checked and it is ensured that budget is prepared in right way.

Disadvantage

• Lot of time is spend on discussion and preparation of budget.
• There is a specific approach that is followed to prepared activity based budgeting for the organization. Under this first of all activity based costing is done by the managers at the workplace. On the basis of activity based costing amount of expenditure that will be made on all sort of activities of the organization are determined. These values are included in the activity based budget. This is the entire approach which is followed to prepare an activity based budget for the organization. It is clear that the application of the activity based costing is different from the other methods (Activity based costing, 2012). This is because in other methods on the basis of likely changes that may take place in the business environment values for the component of the budget is determined. In case of activity based budgeting first of all managements accounting tools and techniques are used to compute cost of each and every activity. Hence, it can be assumed that long process is followed to prepare an activity based budget for an organization. It can be said that there is a great importance of the activity based budgeting for an organization in its business.

Advantage

A better picture of the expenditure that can be made in different activities of organization is obtained from the activity based budgeting.
Operating costs that have higher proportion in overall cost can be identified easily.

Disadvantage

• Lot of time is spend on identifying key activities and relevant cost drivers

6 Appropriateness of the budgeting method for Emilia

Out of both methods zero based budgeting is most appropriate for the Emilia. This is because in this method after considering number of factors final value for the budget is determined. Detail discussion is carried out among the managers if required. Moreover, managers have to give justification about the factors on the basis of which they prepare an assumption. Hence, it can be said that in the activity based budgeting method managers that prepare a projection are fully accountable to the top managers. In case it is identified they wrongly prepare assumptions they can be made liable for their mistakes (Phelp, Webb and Koh, 2011). In case of activity base budgeting cost of the activity is computed and same is included in the budget. Hence, it can be said that activity based budget is a set of cost of different business activities. This method is not appropriate for the firm because in this lots of time is spend by the manager to prepare a budget. Management accountant have to do calculations for the different type of the business activities. Then that values will be incorporated in the budget. Lots of time need to be spend on identification of activities that will be included in the budget. Hence, it can be said that activity based costing method is not appropriate for the Emilia.

Conclusion

On the basis of above discussion it is concluded that there are different type of budgets that can be prepared for the business firm. All these budgeting methods have some advantages and disadvantages. Hence, after considering positive and negative points of the budget specific one must be selected for the business firm. It is also concluded that incremental budget is one which must be prepared by every business firm. This is because under incremental budget values of components are increased. Business revenue and expenses also enhance year by year. Hence, incremental budget suits to all sort of business firms.

References

• Bahrammirzaee, A., 2010. A comparative survey of artificial intelligence applications in finance: artificial neural networks, expert system and hybrid intelligent systems. Neural Computing and Applications.
• Bánciová, A. and Raisová, M., 2012. Issues of Slovak business environment. Procedia Economics and Finance.
• Cheng, B., Ioannou, I. and Serafeim, G., 2014. Corporate social responsibility and access to finance. Strategic Management Journal.
• Hale, T. and Held, D., 2011. Handbook of transnational governance. Polity.
• Hillier, D. and et.al., 2014. Fundamentals of Corporate Finance. McGraw Hill.
• Irwin, D. and Scott, J.M., 2010. Barriers faced by SMEs in raising bank finance. International journal of entrepreneurial behavior & research.
• Klapper, L.F. and Parker, S.C., 2011. Gender and the business environment for new firm creation. The World Bank Research Observer.
• Masca, E., 2012. Influence of Cultural Factors in Adoption of the IFRS for SMEs. Procedia Economics and Finance.
• McLean, R.D. and Zhao, M., 2014. The business cycle, investor sentiment, and costly external finance. The Journal of Finance.
• Munteanu, I., 2012. Bank liquidity and its determinants in Romania. Procedia Economics and Finance.

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