What is a Budget?

"Budgeting is a process of measuring and converting plans for the use of financial values. The process of budgeting the finance function provides the essential link between management planning and management control." Anthony (2007) categorises organisational controls at three levels: strategic, management and operational. Strategic planning involves the use of information on the environment and information on internal service capabilities to determine the future strategy of the organisation. Management control systems entail the implementation of strategy and the effective use of resources. In most organisations budgetary control is one on the most important forms of management control.

Anthony, R.N. and Govindarajan, V. (2007) Management Control Systems (12th Edition). New York: McGraw Hill.

Objectives of Budgeting
The objectives of budgeting depend on two key factors: the type of budget being produced; the organisation for which the budget is being produced.

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Budgets serve a number of useful purposes which are key to an organisations success, i.e. Planning; Co-ordination; Communication; Motivation; Control; Evaluation. Authorisation

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Planning Managers are required to produce detailed plans to enable the implementation of the long term or strategic plan. The annual budgeting process encourages managers to plan for future operations, refine existing strategic plans and consider how they can respond to changing circumstances. This encourages managers to anticipate problems before they arise and ensures reasoned decision making. Without this incentive the pressures of day to day operations may tempt managers not to plan for future operations and hasty decisions based on expediency rather than reasoned judgement will be minimised.

Co-ordination Budgeting facilitates consolidation and co-ordination and allows the actions of the different parts of the organisation to be brought into a common plan. It also compels managers to examine the relationship between the different parts of an organisation when making decisions and in assists in identifying and resolving conflicts. An example of the type of conflict which could arise in a local authority setting would be between a purchasing manager who wants to buy road salt in bulk to obtain large discounts, a stores manager who wishes to avoid large stock levels of salt an accountant who is concerned about a possible overspend on the Highways budget and the Highways manager who wants to avoid running out of salt in bad weather and therefore carry high levels of stock., Budgeting aims to reconcile these differences. Communication Senior management can use budgets to communicate corporate objectives downwards and ensure that other employees understand them and co-ordinate their activities to attain them. The act of preparation as well as the budget itself will also improve communication. All managers within the organisation must have a clear understanding of the role which they are required to play in ensuring budgetary compliance. This ensures that the most appropriate individuals are made accountable for budget implementation. Participation in budget setting relates to the extent that subordinates are able to influence the figures incorporated in their targets. Participation is often referred to as bottom-up budget setting whereas a non participatory approach whereby subordinates have little influence on the target setting process is sometimes called top-down budget setting. Motivation Budgets can also motivate managers to perform in line with organisational objectives. It therefore sets a standard which under certain circumstances managers may be motivated to achieve. It is important, however, that managers are involved in the budget setting process and that budgets are used as a tool to assist them in managing their departments. With top-down approaches there is a risk that dysfunctional motivational will occur. Control Managers can also use budgets to control the activities for which they are responsible. Analyses of variances allow managers to identify those costs which do not conform to the long term plan and therefore may require alteration. By investigating the reasons for budget deviations managers may also be able to identify inefficiencies. The budget forms the basis of a controlling mechanism for the various resources of an organisation which is achieved by comparing the resource measured to the end of a given period with that which was expected. This approach can be used for all measurable resources and activities within the organisation not just those which are directly financial. Budgetary control highlights variations from the expected in order that management can take remedial action to ensure that the policy objectives set in the budget can be met. It is a constant monitoring process

and requires continual updating and amendment of the budget through operational feedback. This also allows for performance against objectives or targets to be measured. Evaluation Budgeting can also be used as an effective management tool. It provides an important mechanism for informing managers as to how well they are performing in meeting targets they have previously helped to set and an employee's ability to meet agreed targets is used is many organisations to determine promotions and bonuses. In this circumstance budgets will therefore influence human behaviour. Authorisation A budget is normally prepared by the management of a public body, but in a democracy is normally approved by a legislative body representing the interests of the general public. Thus the objective of the budget in the public services can be to achieve democratic authorisation to raise taxes and spend money.

Evaluation of the Budgeting Process of Bayer AG

Budget & Budgetary Process

A budget is a powerful business tool that will help you make better decisions. It enables you to develop and maintain a thorough understanding of the internal financial workings of your business ( 2004) Budget inevitable to the business because of several reasons: 1) limited financial resources and 2) accountability. The foundation of accountability is the budget. (2005) Budgetary process means systematic planning, recording and forecasting. It covers planning because it maps out the expected areas of spending together with the apportioned monetary resource. This serves as a guide to the limit of spending of the different operations of the company. It includes recording on printed document of the monetary activities of the business. The budget serves as a standard of performance. It involves forecasting because it shows the pattern of future spending of the company. (2005)

Budgetary Process of Bayer AG

The relevance of budget to the company enhances the importance of budgeting and budget management. Budgeting refers to the activity of matching the various planned actions and objectives with their respective estimated financial resource requirements. The budgeting process of Tesco Plc is evaluated based on the principles of budgeting. The two elements of budget are income and expenses. The proper parties to determine the budget are the people with information about income and expenditure.

(2005) Bayer AG is a pharmaceutical company with various business units covering an array of health care products so that the primary purpose of the budgeting process is to ensure that all the business units are operating in their optimum capability. Based on the consolidated income statement of the company (Bayer AG, 2006), the two important elements of the budget income and expenses are compared to determine performance. Bayer AG has an accounting division that takes charge of consolidating the income and expenses flow of the entire company but crucial information are obtained from the various business units [see Appendix 1]. The top managers of every business unit submit income reports to the company on a monthly basis as well as a proposed budget before the start of every year with monthly expenses itemized. The accounting division considers the performance of the business units, the merits of the expenditure items listed relative to the purpose, and submits their recommendations for approval. Apart from financial data per business unit, the accounting department also consolidates financial information per region [see Appendix 2] as further basis for approving the budget proposal of the regional business units Two basic types of budget exist. One is cash budget that provides an estimate of the cash position of the business in a given period. Cash budget involves the consideration of the liabilities of the business and schedules the payment of these liabilities according to the schedule of the receipt of revenue by the business. Cash budget starts with a list of the starting cash balance followed by expected revenue for the period covered by the budget added to the starting cash and then followed by the expenses such as liabilities deducted from the total cash balance. The positive remaining amount determines the cash earned by the business. (2005,2000,)

Another is operating budget that serves to forecast the revenues and expenditures for a year or less. This involves the listing of income and expenses into two columns, with every source of income and areas of spending itemized to compare the difference in total income and total expenditures. This method is helpful in mapping the revenue generation and spending of every area and stage of the business. Using this method enables the owners/managers to determine and evaluate the financial soundness of the business. (2003, 2000,) Bayer AG is a multinational company with various subsidiaries and business units operating in almost every region in the world. The company also obtains capital through public stock offerings as well as stock options to its employees. (Bayer AG, 2006) The bulk of the sources of income and expenditure items as well as the nonliquidity of some of its assets make it more profitable for the company to utilize operating budget. This type of budgeting plan benefits the company because its covers both liquid and non-liquid assets as well as the itemization of its annual income and expenditures giving the company a view of its performance as a single business firm composed of various contributing business units. The application of the operating budget by Bayer AG is reflected in its consolidated financial reports [see Appendix 3 &4]

Evaluating the Budgetary Process

Four elements need to be considered in evaluating the budgetary process. First is the alignment of the chosen budgetary process with the budget goals of the business ( 2005, 2000). The budget may be for the purpose of planning or scheduling the payment of debt or forecast the future financial performance of the business. Depending upon the purpose, the focus of the budget would also differ. If the purpose were to mapout debt payment, the focus would be on the itemization and spread of the amount to be paid every month based on the expected revenue of the business. If the purpose of the budget is to forecast financial performance, then the focus is on the remaining amount after expenses are deducted from the income. The primary purpose of Bayer AGs budgetary process is to ensure that all the business units are operating at their optimum ability (2006). Since the purpose of the budgetary process is to forecast financial performance, then the budgetary process correctly focuses on the remaining amount after all expenses and liabilities have been

deducted from total income. As the remaining amount increases, Bayer AG is also improving its financial performance because either its expenses are decreasing with stable or increasing revenue or its expenses are increasing at a lower rate than revenue increases. Regardless of the case, the budgetary process supports financial forecasting. Consequently financial forecasting through the budgetary process is geared towards the companys accountability to its stockholders. In the consolidated balance sheet of the company [Figure 4] there are amounts listed as stockholder assets and liabilities. This means that in the consideration of the budget, the company considers its liabilities to its stockholders as expenditure item and stockholders assets as company resources. This is an important item not only for purposes of accountability to stockholders but also for the determination of the total expenses and available financial resources of the company. Second is the complete listing of all sources of income and areas of expenditure ( 2005). This is important because the reliability of the budget depends upon the inclusion of all expected income and expenses. In the operating budget, the items to be included may be the sales revenue, production revenue, total labour cost, operating expenses, and capital expenses. If even a single item regardless of how small is omitted from the budget, the mapping of liability payments and forecasting will be affected. Bayer AG is a large company with various subsidiaries but its business ventures do not always succeed. These changes in the organization structure of the company affect its budgeting process data requirements. Bayer AG integrates depreciation of its capital assets, exchange rate fluctuations relative to significant local currencies, and closed and newly opened subsidiaries in determining its income and expenses. ( 2006) Depreciation means that the valuation of the companys assets would decrease every year for naturally depreciating assets such as building structure and machines but this also implies the inclusion of capital maintenance in its budget. Exchange rate fluctuations change the budget of the various units, either decreasing or increasing the amount when converted into the local currency, especially with fluctuating rates. Closed and newly opened subsidiaries affects the budgetary process by including as expenses the amounts necessary to close down a subsidiary such as severance pay for dismissed employees or to open new subsidiaries such as acquisition fees.

Third is accurate estimation of amounts based on previous financial performance by using income statements, balance sheets and other relevant finance documents (2000,2000). Accuracy is important because this adds reliability to the budget especially if the budget serves as a guide to the limit of spending of the business. In a time of tight budgets, difficult choices have to be made. We must make sure our very limited resources are spent on priorities. ( 2006) Bayer AG has a consistently accurate estimation for its budget especially since it has adopted information and communication tools as well as IT software to facilitate the sharing of financial data to and from the accounting department of the company with the various business units ( 2006). In this way, the company ensures the reliability of its data by preventing the possibility of over reaching or under estimating financial allocation due to insufficient or inaccurate data. Fourth is flexibility to variances (1994 2000;). Although, the budget is a mere estimate, it should be accurate enough to be reliable but flexible enough to cover any changes in the financial performance of the company due to both internal and external forces. According to (1991) never base your budget requests on realistic assumptions, as this could lead to a decrease in your funding so that budgets should consider allowances particularly in large businesses with big budgets. Bayer AG utilizes its IT software to determine the possible effects on the budget of changes in income and expenditure items throughout the course of the year covered by the budget. Variables such as exchange rate fluctuations and market conditions are tested through the IT software. (2006) The various business units also provide allowances for their proposed budgets because it is better to operate below the amount budgeted rather than to overspend contrary to the budget principle of (2006) that even though I can make my own budgets, I always ask for less money than we need so that you have to be more creative, you have to strip it down. Budget process evaluation also involves the determination of the efficiency of the process based on the appropriate budget approach. Top down, bottom up and zerobased budgeting processes are three budget approaches. In a top down budget approach means that budget is prepared by the owners of the business and implemented downwards to the rest of the organization. Top down budget reflects the goals of the owner/managers. This works for small businesses but subject to limitations in large firms. Bottom up budget are prepared by supervisors or middle managers and then submitted upwards to the owners for approval. This applies to large businesses

where middle managers are most qualified to provide information on the income and expenses of their division. (2000) Zero-based budgeting works through every manager providing an estimate of the proposed expenses in their area of responsibility. (2004) As a multinational corporation with geographically spread business units, Bayer AG utilizes bottom up budgeting and rightly so because the top managers of every business unit are in the best position to determine their expected expenditure items. Thus, Bayer AG adheres to a good budgetary process. This is observed through the financial performance of the company and its incessant expansion. The closure of some of its subsidiaries is due to failed marketing plans or unsuccessful research and development ventures but not due to its budgetary process. Moreover, an innovative firm such as Bayer AG expects to takes risks especially in research and development. Due to expected risks, its sound budgetary process proves as a valuable asset to the company.

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