For a smooth running of any given business, organization or activities that require finance for operation, tend to need a budget. A budget is a comprehensive, reserved arrangement that estimates the possible expenditures and income for an individual or an organization over a definite period of time. This tool is used to ensure that the available and required resources are utilized effectively and efficiently for the achievement of the set goals and objectives. A budget is a monetary analysis of the expected incomes and expenditures and is mostly set for a period of one year or above depending on previous budget or an already made plan (Cleverly and Cameron, 2007).
Budgeting is the process of planning and monitoring the utilization of the available resources in an organization's activities. It covers all the business operations, finances and the profits thereby putting forward a performance guideline that will help managers determine the most effective way to utilized those resources. No matter how a budget is closely monitored, there is always a cost variance in the long run. Any given organization ought to set strategies that can absorb these changes and be able to work with such financial constrains. They main reason for budgeting is to help a business or an organization to fully utilize its limited resources be it financial or human for the achievement of maximum output. When a budget is done by several different people, the plan becomes crucial.
Therefore, for the implementation of such a budget need a person who can be trusted with the finances of such an organization so as to manage its resources. To achieve the set goals of the budget, several strategies have been found to work effectively. This paper assesses strategies that can be used to manage budgets within forecasts and the possible reasons for variance comparing several expense results within budget expectations with the recommendation of benchmarking techniques that might be used to improve budget accuracy in future forecasts.
Cost variance can be defined as the difference in the amount of money that was spent in reference with the budgeted costs. These differences occur when the final results of a given activity are implemented and the result differs from the projections in the standard budget. The reasons for budget variance might be from the knowledge of pervious finances and other factors therefore leading to inaccurate estimations (Lee, 1963).
When creating a budget one ought to have done an initial analysis of the costs to be incurred. When doing this, one ought to gives himself a chance for cost changes. These estimates can be result to be favorable or unfavorable. Perhaps when doing the estimates, one might have overlook or ignored some factor. If some factors have a direct effect on the costs, then there will be unexpected change leading to variance in the budget. There are strategies that can be used to manage budget variances within forecast (Shim & Siegel, 2000). These factors include planning.
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Planning before doing a budget mainly needs a continuous evaluation of costs. This can also be used to achieve a result of an expenditure that is within the budget. Planning focuses on the future. Therefore anticipation of a higher or a lower variance in the budget can be a working strategy when employed in an organization so as it can work within the set budget forecasts. Once an organization has set the goals of each department, the management ought to forward each section of the budget to the corresponding department. In an example, a manufacturing company can subdivide it budget for each department. The department of purchases can be given their budget line. By this kind of plans, this department will know their limits of expenditures and they can not go over board. Therefore subdivision of the main budget and letting each department have its own limits of expenditure will help that company in working within the budget forecast.
For an organization to work within budget forecast, it ought to have a price comparison in terms of quotations. Before doing any given purchase, they ought to have different suppliers providing their quotations on the price they would offer their serves or products. These quotations help to reduce the material price variance which is brought in by the standard price and the actual price of the material. Therefore when an organization applies the quotations strategy then they will reduce inaccuracy when estimating the standard price per unit of the materials to be bought.
Another strategy to apply so as to work within the budget forecast is buying or doing purchases in bulk. When an organization plans to buy frequently used products in bulk, they are subjected to be offered a discount that will bring in a favorable variance. The organization will have surplus funds and they can be used in other areas of activities.
For an organization to have higher profits and be within the budget, they must improve their efficiency in utilizing the available resources. Efficiency reduces wastage of resources leading to higher profits. That organization will save on materials and the cost of manufacturing will be reduced. The consequences of efficiency will be directly felt on the budget. Therefore that organization will work in line with the budget forecast. This will lead to favorable variance.
Strategies that deal with human resource in organizations are not well received. However, when an organization performs a human resource audit, it will reduce idle labor where staffs tend to waste time that they are paid for. Also the organization will increase its productivity when the audit is done as it will sieve out the inactive staffs' and hence a positive and favorable effect on the budget. Therefore the organization can be able to work within it forecasts as its outputs will be high than its inputs in terms of labor.
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Expense results must always be expected in any organizational budget. Such results would have an effect on the planned budget. Some these results include material cost variance, labor cost variance, variable overhead costs, material price variance, labor rates variance and variable overhead expenditure variance. These results have effects and their possible reasons for their occurrence (Roberts & Russo, 1999)
Material cost variance is the difference between the actual cost incurred on material and the actual standard materials cost allowed for the production level achieved. This is achieved by multiplying the number of times of the actual output and the standard cost per unit of output then less the actual cost. The possible causes of variance in the cost of material can definitely be an increase or decrease in the prices of the materials. Also the use of materials of different qualities can lead to a variance as they produce different qualities of products. The difference in the rate in which the materials are mixed can lead to a variance also. If the rates of mixing the materials during production are high, then there will be variance in the budget as more materials are used. In the other handle, if the materials are mixed in a lower rate than planned, there will be a favorable variance in the budget but a poor output.
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Labor cost variance is the difference between the standard labor cost allowed for the production level achieved and the actual labor cost incurred. This is obtained when the output is multiplied by the standard labor cost per unit of output then less the actual labor cost. Possible cause of this change can be an increase or a decrease in the actual wages rate. These can be due to inflation. When a country is experiencing difficulties in its economy, its citizens tend to require more pay as the country's living standard go up. Other possible cause of labor cost variance would be an increase or a decrease in idle time. When workers have a loner idle time, their output will definitely decrease. Other possible factors to this kind of variance include wrong estimates of the standard labor cost per unit of output and the employment of unqualified and unskilled staffs.
The difference between the actual variable overhead cost and the standard variable overhead cost allowed for the production level achieved can be termed as variable overhead costs variance. This is achieved when the number of output is multiplied by the standard variable overhead cost per unit of output then less the actual variable overhead cost. These are the organizational expenditures; they can be fixed or variable. They may include costs like rents, electricity and the cost of raw materials. These variances can be caused by the increase or decrease in the variable overhead expenditure level. Also a change in the efficiency of the employees would lead to a variance in the variable overhead costs. During production, some costs can be variable. The costs of these products are estimated and are subjected to change. Therefore such variables vary with the output. A cost like electricity is variable in terms of output as more output is produced, the electricity cost will be higher therefore leading to change in the budget forecasts. Other factors that might lead to a change in this kind of variance include higher costs of production due to higher standards of living and change of economy.
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Material price variance arises from the difference between the standard price and the actual price of the materials multiplied by the actual quantity. The standard price is the budgeted price. The actual price might have a favorable or unfavorable variance. The possible causes of this variance might be due to higher production cost of the products as a result of inflation within a country's economy. Other causes include discounts arising from the bulk purchases and use of materials of different quality. Wrong estimates of the standard cost of material would lead to a variance in the budget forecast. Natural calamities like drought and floods can make the prices of a given material to go high.
The portion of the labor cost variance arising from the difference between the standard labor rate and the actual labor rate is termed as labor rates variance. During budgeting the labor rates are set as fixed. But due to factors like higher living standards, the company end up offering higher rates than the budgeted ones. Other causes of this kind of variance would include new employees of different skills who would need higher or lower labor rates. Other factors which will lead to a variance in the budget costs would include unanticipated bonus to the workers.
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Variable overhead expenditure variance is the portion of the variable overheads cost variance arising from an increase or decrease in the variable overhead expenditure level. This arises due to payment of rates that are higher or lower than the standard rate for the hours worked. Government policies can be a likely cause of this kind of variance. In given circumstances, the government can come up with policies that state that the pay of a casual laborer will rise from a given figure to a higher one. Therefore, the organization will result to a budget variance due to these unexpected changes. Also availability of cheap labor can lead to a variance as there will be surplus funds within the organization which were obtained from the difference between the standard cost and the actual one.
For the achievement of an effective and accurate budget, organizations can incorporate benchmarking techniques that will lead to improved budget accuracy in future forecasts. Some of these techniques would include incorporating the staffs during budgeting, using payments as motivators and using the budget as the target.
Individuals will tend to work harder to achieve a budget if they know they will be rewarded or promoted for their efforts. Rewards based on a formal performance evaluation and giving individuals incentives to achieve a good performance level is a benchmarking technique to be employed in an organization to achieve the set goals. This technique was applied by Microsoft Corporation in the United States and the results were overwhelming. The company rewarded the best performers and gave warnings to the lowest producers within the organization. For a period of two years, the results were outstanding as the company became the most reputable company in the stock exchange (Watson, 1993).
Involvement of staff during budgeting is another benchmarking technique that would lead to an effective and accurate budget. Staffs are well informed of the actual costs and expenditures as they are the ones who implement the plans. Therefore when budgeting, it's wise to involve them and this gives them a sense of ownership as they get recognition during such an event. This will motivate them and hence accurate future budget forecasts. This technique was applied by the metropolitan council of New York in their 2009-2010 budget preparation. They were able to achieve their set goal of revenue as each employee knew the exact requirements and the plan to be achieved. The tax collection systems were streamlined leading to over achievement.
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Other benchmarking techniques to achieve the best results in a forecast budget can be using the budget itself as the target. Each and every individual would be informed of the budget lines and therefore when they are implementing, they would have the budgeted figures in mind. By doing this, there will be an improvement in the level of performance.
Budgeting is a cumbersome process that needs skilled personnel and the employment of complex techniques for the achievement of an effective and accurate result. To be able to achieve this, any given organization must utilize its resources to the fullest so as to have maximum outputs.
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