Advantages and Disadvantages of Budgeting for Organizations: An Analysis of Two Journals

This project discusses the advantages and disadvantages of budgeting for organizations with reference to two scholarly reviewed journals. The advantages of budgeting include achieving financial objectives, estimating expenses, tracking expenses, estimating future money requirements, and organizing expenses. The disadvantages include increased cost and workload, departmental strife, inaccuracy, overspending, and complexity. The two journals analyzed the capital budgeting practices in Australia and Canada, respectively, and highlighted the importance of DCF technique and weighted average cost of capital method. The research questions and similarities and dissimilarities between the two journals are also discussed.

Managerial Accounting
Assignment

By student name
Professor
University
Date: 5th Sep 2018.
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Executive Summary
This project deals with the topic budgeting where I have discussed about the topic with reference
to 2 different journals. Through this project the different advantages and disadvantages of
budgeting for an organization is studied. Moreover the 2 journals are discussed thoroughly and
learning from the same is also stated.
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Table of Contents
Executive Summary.....................................................................................................................................2
Introduction.................................................................................................................................................4
Advantages of Budgeting.............................................................................................................................5
Disadvantages of Budgeting........................................................................................................................6
Purpose of the two articles..........................................................................................................................7
Analysis of the journals and the research questions-..................................................................................8
Similarities and Dissimilarities of the findings of the studies.....................................................................10
Specific Outcomes and Relative Learnings from the Research Findings....................................................12
Conclusion.................................................................................................................................................13
References.................................................................................................................................................14
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Introduction
Budgeting or simply budget is the process of deciding the maximum amount that we plan
to spend for a project. Be it a company or household budget is the most common term that is
necessary for any project. It is a plan that decides the total sum of money that the company
would spend within a given period and the total amount the company can save during the same
period. If the company does not have a proper plan of its expenses it will not be able to save any
amount from a project, rather it may incur losses due to nonexistence of a well-planned budget.
Thus, a budget prevents unnecessary spending by people. Budgeting involves different tools for
preparation of budget such as determination of incomes and expenses, establishment of cost
constraints and enabling the existing business operation against the determination. For
uninterrupted performance of any business a proper plan is most significant without which the
organization must face various financial problems (Bromwich & Scapens, 2016). Different types
of organizations use different types of budgets such as cash budget, sales budget, capital budget,
production budget, marketing budget, revenue budget, performance budget, expenditure budget,
project budget, flexibility budget, zero based budget and appropriation budget. Although we will
discuss all the above-mentioned budget but we will use only capital budget for the analysis of the
journals. Cash budget involves the total cash inflows and outflows for the company during the
given period. This budget helps in determining the total cash revenues and expenditure for a
period. Sales budget estimates the total sales that the company would be able to make in the
given period and thus sets sales targets for the company (Belton, 2017). Capital Budget relates to
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the cost incurred by the company on long term investments which also includes fixed assets. The
NPV of these assets is calculated to know their true value on today’s date. Production budget
determines the total units that the company needs to produce to meet the requirements of the
sales budget. Marketing budget estimates the total amount of expenditure that the company plans
to spend on the promotion and marketing of a product. Revenue budget predicts the expenditure
related to the revenues of the government after netting off with the same. Performance budget
analyses the performance of the company (Visinescu, et al., 2017). Expenditure budget deals
with all the expenses that the company has incurred during the period. Project budget estimates
the total cost of a project. Flexibility budget determines the variable cost with the help of
variable rate of each activity and the fixed cost associated with the company. Zero based budget
is prepared for careful apportionment of cost due to scarcity of resources. Finally, Appropriation
budget is prepared for determination of total amount that the management allots for a specific
expenditure. Along with these budgets the advantages and disadvantages associated with
budgeting is also discussed in this report (Truong, et al., 2008).
Advantages of Budgeting
Budgeting is very important for any type of organization. It is also very useful for the one using
it. The advantages of budgeting are listed as follows:
1. It focuses on achieving the financial objective of the company by reducing those
expenses which are not necessary for the business. It is very useful for companies having limited
resources as it is directed towards money related objectives (Naci & Hasan, 2012).
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2. With the help of budget, the company can estimate the total expenses which prevent lack
of funds in the organization. Through this it calculates the total sum to be saved and thus helps in
controlling money.
3. By using the budgeting techniques, the company is sure about the areas where money is
spent, thus keeping the track of its money. It shows us the total inflows and outflows of the
organization which makes it easy for the management to take decisions on planning with respect
to raising of debts and investment opportunities.
4. It makes it easy for the organization to estimate the future money requirement through
which it decides how much amount should be invested in each area.
5. With budgeting the company divides its total expenditure and savings into different
categories which enable them to organize its expenses and savings properly. Thus, making it
easier for them to analyses each category based on proportion of savings and expenditure and
make any adjustments accordingly (Linden & Freeman, 2017).
Disadvantages of Budgeting
The major disadvantages of budgeting faced by the organization are as follows:
1. Budgeting involves employment of extra manpower for collection and evaluation of data
making the process more expensive and time consuming for the organization. So, it increases the
cost of the company and workload of the managers as its reliability must be checked when it is
complete.
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2. It is the responsibility of the management to allocate expenses among various
departments which may lead to strife among the departments due to the methods used for this
purpose. Many controversies are created between the departments because it is practically
impossible for the management to consider the suggestions from each department (Heminway,
2017).
3. It is prepared on assumption basis which raises the possibility of inaccuracy. The budget
is prepared based on the current market trends and scenario through which the company
estimates its future expenditure and income. The cost of preparing the budget is affected
significantly due to changes in economic behavior of the bases on which it is prepared.
4. Some managers believe in spending the entire amount of funds allocated to their
department with the fear of reduction in next year’s budget by the unspent amount of the current
year. Due to this the managers leads to spend more than they require to spend. Thus, we see that
budgeting can cause rifts between the department where they will want their specific budget to
be passed and given that the resources are limited it is not possible for the companies to act in
this regard (Bennouna, et al., 2010).
5. Budgeting is also based on the concept that there is a lot of cost involved in case of
budgeting and timely updating of the same is regard with respect to the company, thus we see
that budgeting is a complex process and requires lot of cost and effort on part of the management
and thus we see that it is a major disadvantage for the company (Heminway, 2017).
Purpose of the two articles
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For this assignment two articles on budgeting has been selected that highlights the different
aspects that are related to it in some way or the other. Both are the articles have been written by
professionals and are scholarly reviewed. The first article that has been selected is, “Cost of
Capital Estimation and Capital Budgeting Practice in Australia” by Gang Truong, Graham
Partington and Maurice Peat (Truong, et al., 2008); secondly, “Improved Capital Budgeting
Decision Making: Evidence from Canada” by Karim Benoni, Geoffrey G. Meredith and Teresa
Marchant (Bennouna, et al., 2010).
Analysis of the journals and the research questions-
In the first journal the author has stated the overall importance that is related to capital
budgeting and have highlighted the evaluation of the same in case of corporate finance in
Australia. The various aspects that have stated in the article are use of real option analysis
instead of the discounted value of cash flow technique, the various discount rates that the
companies can use, the inputs that the management uses while applying the principles of CAPM.
It also analyses the difference between the regulatory practices and the Australian corporate
policies that the companies follow (Fay & Negangard, 2017). The authors have also stated the
various tables and charts that highlights the estimation of the cost of capital as per the policy of
the CAPM. The author has also done various surveys that includes large organization and how
are they applying the policies of CAPM when it comes to capital budgeting. It was found that
evaluation of the techniques used by the Australian Companies, and it was seen that net present
value method was used by 82 companies out of which it was found that 94 percent of the total
responses and 13% of the total responses were included by 11 companies (Alexander, 2016). The
following research questions that can be stated –
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• How the policies with relation to Australian Accounting Standards and other regulatory
policies, have improved over the years and how companies are benefiting from the same?
• How many companies are using the policy of NPV and cash flow methods for practical
application when it comes to their business?
The second article talks about the policies of capital budgeting with contest to the regulatory
policies that are being practiced in Canada when it comes to capital budgeting decision making.
The various trends in the process of capital budgeting has also been discussed. There has been a
gap of around 50 years in the analysis that has been done by the companies in this contest. The
authors have stated that companies are not using the cash flow method for the analysis of their
investments and neither they are doing proper utilization of the DCF technique. The overall
determination of the cash flow was not proper for the company, moreover the basis for the DCF
technique should be cash flow method and not the accounting income method. The companies
want that inflation should be recognized as an important factor when it comes to capital
budgeting process (Knechel & Salterio, 2016). It is important that while taking such decisions
weighted cost of capital should be considered and no single cost should form the basis for the
companies. In case of Canada the concept of taking weights for analysis is still not relevant.
Many companies must face difficulty when it comes to analysis of the cost based on the
divisional distinction between the companies. For effective analysis it is important that risk
element should be considered by the companies, also they should highlight any issues they face
when comes to practical adoption of the theoretical data. 88 firm were surveyed in Canada and
out of that it was found that 17 firms did not use the technique of sensitivity analysis and DCF.
The survey had a lot of limitations as it was restricted to only few large firms and not many
companies were involved in that so it cannot be said that results are very much reflective of the
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practices that are carried out in general (Knechel & Salterio, 2016). Most of the managers are
still considering IRR as the key element that can help them in decision making which is having
its share of disadvantages. The following research questions can be set –
1. What are the ways in which the Canadian firms are adopting the capital budgeting
methods and what are the various techniques that they are following and how much it has been
effective since the past years?
2. What are the overall improvements that have happened in case of Canadian Regulatory
Practices and how companies are applying the same for evaluation of their techniques of capital
budgeting?
Thus, we see that both the research articles are talking about how the regulatory policies have
affected the overall methods of capital budgeting and how they can be changed. Few similarities
and dissimilarities between the research articles have been stated below:
Similarities and Dissimilarities of the findings of the studies
The following similarities between the 2 studies were observed during the study:
1. DCF technique is the most widely used capital budgeting technique as said under both the
journals. This is because the said technique is based on cash flows and not accounting income.
The technique is directed towards calculation of present value of estimated future cash flows
which helps in determining the real future income as per the present date. Both the authors
emphasize on recognizing the above technique and rely on discounting rates as used under
weighted average cost of capital method (Choy, 2018). As per both the authors effective capital
budgeting starts with proper utilization and adoption of the DCF technique.
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2. The main emphasis by both the authors was on the capital budgeting technique and
different methods of applying it. They focused mainly on the techniques used under corporate
finance such as the CAPM model, DCF technique using both the cash flows and cost of capital
as the basis of calculation, the net present value method, the internal rate of return method, the
payback period method, dividend imputation technique, the weighted average cost of capital, etc.
Both the authors described about the different methods used by the companies for capital
budgeting and the advantages and advantages of each of these methods in details. The main aim
of both the authors is to bring out the effectiveness of the methods used by the company and how
far the company is successful in implementing the same. They also discussed about the
challenges faced by the companies while using the above-mentioned techniques and the
disadvantages for the company attached with each method they use. Both discussed about the
different types of risks that the company bears while using the above techniques and suggested
the tools for the measurement and control of each type of risk.
The dissimilarities between both the journals were as follows:
1. Decision making on capital budgeting by the Australian companies is discussed in the
first journal in comparison to discussion relating to Canadian capital budgeting technique and its
improvements as discussed in the second. In the first journal the author focused only on the
decision-making technique using the CAPM model and discussed about the other methods
considering the same. Whereas in case of second journal the author focused mainly on the DCF
technique using cash flows and the cost of funds as the key parameter (Goldmann, 2016).
2. The first journal emphasizes on estimation of cost of capital whereas the other focuses on
improvement in decision making under capital budgeting.
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Specific Outcomes and Relative Learnings from the Research Findings
The outcomes derived from the first journal are as follows:
1. For the estimation of cost of capital CAPM model is the most widely used method as the
asset pricing model throughout the continent. For discounting rates, the most common weighted
average cost of capital method is widely used by most of the companies operating within the
national boundaries of the island continent. The most common techniques used by the companies
as their risk evaluation technique is the fixed discount rate. Although it was observed from the
study that the risk varies with respect to time and the companies agrees to the same.
2. The companies use many other alternative techniques such as the payback method or the
internal rate of return(IRR) method along with the commonly used net present value(NPV)
method for project evaluation. Thus, the use of alternative techniques for the same work instead
of single capital budgeting technique is very common between the companies of this territory.
Another option for the evaluation of the projects that came up as a popular technique is the real
options technique. This method is considered as unimportant as mostly the users of this type of
technique are substantially minor (Alexander, 2016).
Many points were found in the second journal that needs special attention and required to be
discussed accordingly. Following are the outcomes derived from the journal and the learnings
from the same:
1. There were many sectors that were ignored and which requires more attention for
improvement in the process of decision making on investments. The discounting cash flow
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(DCF) technique which is the most commonly used techniques also needs much improvement
but the same has been restrained.
2. For the investment decision making process the most commonly used technique is the
discounting cash flow technique (DCF) which also has the highest recommendations for the said
process. This method has become a standard technique due to which the use of non DCF
techniques has reduced considerably although it is still adopted by some firms (Bennouna, et al.,
2010).
Conclusion
Based on the overall analysis capital budgeting is a complex process and it is important
that organizations need to have proper knowledge so that they can make better application of that
so that they can reap in benefits from them. From the above analysis companies have failed to
adopt to the changes that have occurred in the capital budgeting methods and policies and still
there are companies that are not able to apply these principles. Out of the surveys conducted only
large firms have been using capital budgeting as a technique for their organizations but rest
smaller organizations are still left to adopt these for mainstream accounting and disclosure.
Hence, we can say that still there needs to be changes made so that such huge benefits that are
associated with capital budgeting can be reaped.
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References
Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp.
411-431.
Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat
International ltd.
Bennouna, K., Meredith, G. & Marchant, T., 2010. Improved capital budgeting decision making: evidence
from Canada. Journal of Mnagement Decisions, 48(2), pp. 225-247.
Bromwich, M. & Scapens, R., 2016. Management Accounting Research: 25 years on. Management
Accounting Research, Volume 31, pp. 1-9.
Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis.
Ecological Economics, p. 145.
Fay, R. & Negangard, E., 2017. Manual journal entry testing : Data analytics and the risk of fraud. Journal
of Accounting Education, Volume 38, pp. 37-49.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business.
Financial Environment and Business Development, Volume 4, pp. 103-112.
Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and
Organic Documents. SSRN, pp. 1-35.
Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business
Ethics Quarterly, 27(3), pp. 353-379.
Naci, T. & Hasan, O., 2012. The Measurement and Management of Unused Capacity in a Time Driven
Activity Based Costing System. Journal of Applied Management Accounting Research, 10(2), pp. 43-55.
Truong, G., Partington, G. & Peat, M., 2008. Cost-of-Capital Estimation and Capital-Budgeting Practice in
Australia. Australian Journal of Management, 33(1), pp. 95-121.
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Visinescu, L., Jones, M. & Sidorova, A., 2017. Improving Decision Quality: The Role of Business
Intelligence. Journal of Computer Information Systems, 57(1), pp. 58-66.
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