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Book Corner
Signs of Budget Ineffectiveness
March 2006
An operating budget is a projected and, it is hoped, realistic number
picture of income and cost objectives for a period, write Steven Bragg and E. James Burton in the second edition of Accounting and Finance for Your Small Business.
A business owner should regularly review the company budget to ensure it is effective. In this excerpt from the book, the authors list some signs that the budget or budget process is less than optimally effective:
- Management or supervisory inattention to the budget. Since a budget is, or can be used as, a measurement tool, accountability and review are necessary for control. Without review, there can be little corrective action, and thus there is a loss of control. If management is not using the budget as a control tool, determine whether the problem is with the budget or with the management.
- A lack of complete participation by all levels of management within the firm. Budgets dictated from upper management without input from the accountable people may have negative effects on the psychology of the employees and lower management. An attitude of "It's their budget, let's see them make it!" may develop.
- Uncorrected large variances between planned performance and budget objectives. Large budget variances may indicate one of several weaknesses:
- Poor estimates
- Poor feedback and lack of timely, corrective action
- Ineffective management policies concerning budget maintenance
- Lack of participation in the operation of the business by those who actively prepare the budgets. Without a working knowledge of the dynamics of the operations of the business, it is difficult to maintain a working knowledge of current operational status. The amount or frequency of contact with operating departments is usually directly related to the stability of processes. The greater the variability in the operations of the business, the more frequently those who prepare the budget should observe and experience the operating environment.
- Supervisors or first-line managers do not know how their budgets were determined or what is contained within their budgets. In such cases, department managers do not know how performance is being evaluated, how well they are performing to expectations, where they may be doing well, and where they are experiencing unplanned difficulties.
Budgets of all types are good planning tools and can also serve a very valuable control function. In order to be used for control, these systems must supplement the budget process:
- Feedback loop. Creating the budget itself does not cause programs to be installed to implement the budget. A feedback loop is necessary to direct attention to areas where difficulties may be encountered in meeting the business plan. Periodic budget reports should generate feedback on performance against budget. These reports should trigger action. If the budget and related performance against budget reports do not flag attention to problem areas, you are missing the opportunity for needed improvements.
- Feedback frequency. The feedback loop requires continuous measurement of performance to budget estimates. For feedback to work properly, it should be regular, expected, and consistently reported. Comparisons are most effective when they are done regularly, consistently, and timely. Trend analysis of budget performance is a good early warning device. Of course, benefits of the budget reporting process must outweigh the costs. However, the ongoing evaluation process is one of the places where you should realize substantial savings.
2006 Accounting and Finance for Your Small Business, 2nd Edition. Wiley 2006. Excerpted with permission.
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