Budgeting in Organizations: Advantages, Disadvantages & Journals

This report provides a comprehensive analysis of budgeting, covering its advantages and disadvantages within organizations. It delves into capital budgeting through the examination of two academic journals: "Cost of Capital Estimation and Capital Budgeting Practice in Australia" and "Improved Capital Budgeting Decision Making: Evidence From Canada." The report discusses the purpose and research questions explored in each journal, highlighting similarities and differences in their findings. Key learnings from the research are presented, offering insights into the practical application and theoretical underpinnings of capital budgeting techniques. The report also addresses various budgeting types, emphasizing capital budgeting and its role in financial planning and decision-making.

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Date: 5th Sep, 2018.
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Executive Summary
This report has been prepared and presented on the topic budgeting. We have discussed the
various advantages and disadvantages of budgeting in the organization. For a clear
understanding of the topic we have consulted two journals on capital budgeting specifically.
The leanings from the journals are discussed below in this report. The advantages and the
disadvantages of the budgeting system to the business has been discussed. Also, the similarities
and the differences in the 2 studies and the research journals has also been discussed along
with the key learnings from both of them.
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Table of Contents
Executive Summary.....................................................................................................................................2
Introduction.................................................................................................................................................4
Advantages of Budgeting.............................................................................................................................5
Disadvantages of Budgeting........................................................................................................................6
Discussion on the two journals....................................................................................................................7
Explanation Of The Selected Management Accounting Topic.................................................................8
Purpose of the studies and the research questions set out to be explored............................................8
Similarities and differences between the findings of the 2 studies.......................................................10
Specific outcomes and relevant learnings from the research findings..................................................11
References.................................................................................................................................................13
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Introduction
In today’s world, Budget is a commonly used term, be it in the corporate environment or in the
household. To state in simple words, a budget is nothing but just a tool used for managing the
finance. It helps in planning the expenses and income for a given period so that a person can
inculcate a habit of savings and thrift. In the absence of a pre-defined budget, a person will not
be able to save money systematically and even if does, he will not be able to manage his
savings and as a result will watch it pass away from his hands. Creation of a budget in a way
curbs the mindless spending of people. So we can say that budgeting is a step of creating a plan
in order to spend your money right. There are various tools of budgeting for the purpose of
determining a budget (Bena, et al., 2017). These involves providing an estimation of
expenditures and revenues; enabling the actual business operation against the estimation and
the establishment of various cost constraints. Budgeting is of great significance for the smooth
operation of the business of any and every organization. If an organization does not plan a
budget then it ends up playing a host to various problems relating to finance. Every
organization, irrespective of its size and years of operation, needs to plan a fair and effective
budget, failing which there ought to be various financial problems which the organization
should prepare itself to face. There are various types of budgets used in different types of
organizations. These are: sales budget to estimate the amount of future sales for obtaining the
goals of a company in respect of sales; Production budget which determines the estimation of
the quantity of units required to be produced by the company in order to the goals set in
respect of sales (Clarke, 2013). It also estimates the various cost involved with the production
process; Capital budget which determines the net present value of the costs involved in the
long term investments of a company like plant, machinery, replacement of plants etc.; Cash
Budget estimates the total cash expenditure and cash receipts for a given period. All the cash
inflows and outflows are included in this budget; Marketing Budget which predicts the funds
required for the promotion and other related expenditures of the product produced by the
company; Project Budget that shows the cost which is associated with a particular project of
the company; Revenue Budget shows the revenues of the government and the expenditures
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related to these revenues after netting off; Expenditure budget includes all the expenditures
incurred by the company; Flexibility budget is created for the estimation of fixed costs as well
as the variable rate for every activity for determination of the variable cost; Performance
budget is created to evaluate the performance of the company; Appropriation budget is used
for establishing the maximum amount for a specified expenditure as decided by the
management; lastly the Zero based budget is created when the resources are limited and is
needed to be apportioned very carefully. We have discussed all the possible types of budget
above, however for the given assignment our main focus will be on the capital budget. Based
on two journals the discussion will be done below in this report. We have also discussed the
various advantages and disadvantages of budgeting in this assignment prior to discussing the
journals (Visinescu, et al., 2017).
Advantages of Budgeting
Budgeting is important in every segment of business and every sector of an industry. The main
advantages it has are discussed in brief here. These advantages are as follows:
a) It helps in having control over the money. With the preparation of a budget an
organization is able to control the money by estimating and planning the amount to
spend and the amount which is required to be saved. This prevents the circumstances of
lack of funds as the organization will be able to estimate the expenditure beforehand.
b) It helps in focusing on the goals related to money. By limiting the amount of
unnecessary spending on goods and services which are not required and focus on
contributing to the achievement of financial objectives of the company, it is very helpful
in case of the companies whose resources are limited (Naci & Hasan, 2012).
c) Budgeting helps you in keeping a track of your money. The cash budget discloses the
amount of cash inflows and outflows which helps the organization in planning. With the
help of budgeting an organization can avoid the situation where it has to wonder where
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the money was actually spent. It also enables an organization in decision making process
relating its debts as well as investing prospects.
d) With the help of budgeting, an organization is able to organize properly its savings and
expenditure. By preparing budgets an organization can divides its savings and
expenditure into various categories and evaluate the proportion of savings and
expenditures allocated to each category. This makes it easier for the organization to
make any required adjustments (Raghupathi & Wu, 2018).
e) An organization will be able to decide which part of the money will be used in which
manner in advance. This makes forecasting the future needs and requirements of
money easier for the organization.
Disadvantages of Budgeting
Even though, budgeting has various advantages as mentioned above, there are certain
drawbacks faced by budgeting. These disadvantages are being pointed below:
a) Budgeting faces the issues relating to inaccuracy. Budgets are prepared on the basis of
various assumptions relating to the expenditures and incomes. All these assumptions
are based on the market trends and scenarios which were prevailing when the budgets
were prepared. These are also prepared with the help of estimations relating to the
future depending on the information and data available at time of preparation. Any
change in the economic behaviour on the basis of which these budgets were prepared
will affect the costs and expenditures significantly (Fay & Negangard, 2017).
b) The process of preparing a budget is in fact expensive as well as time consuming. An
organization has to employ extra manpower for the collection of data and the
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preparation of budget. This adds up to the costing of a company and also the time of
the management as they have to oversee the budget finally prepared is reliable or not.
c) The budgets sometimes leads to excessive spending by the managers as some
managers are of the view that the funds which are apportioned to the departments are
required to expended. They believe that if they fail to spend the funds which are
apportioned to them, then the amount of apportionment to their department in the
next period will be reduced by the amount not spent by them in the current year. This
leads to unnecessary spending by the managers (Choy, 2018).
d) The methods used for the allocation of expenses amongst the department at the time
of preparation of the budget might cause issues and strife among the various
departments. The allocation of expenses is the responsibility of the management. It is
practically very cumbersome to take under consideration the suggestion of each and
every department regarding the allocation of costs and expenses amongst them. Hence,
this creates a lot of controversies in the organization among different departments.
Discussion on the two journals
For the preparation of this assignment we have taken under consideration and studies two
journals relating to budgeting. There are various kind of budgets prepared by an organization,
we have done this assignment by taking journals on capital budgeting. The two journals are,
firstly, “Cost of Capital Estimation and Capital Budgeting Practice in Australia” by Giang Truong,
Graham Partington and Maurice Peat; secondly, “Improved Capital Budgeting Decision Making:
Evidence From Canada” by Karim Bennouna, Geoffrey G. Meredith and Teresa Marchant
(Jefferson, 2017).
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Explanation of the Selected Management Accounting Topic
The first journal is the analysis of the practices of capital budgeting by the Australian
companies listed in the Australian Exchange, while the other journal analyzes the improved
decision making process on capital budgeting in Canada. Both the journals are discussed below
in detail.
Purpose of the studies and the research questions set out to be explored
In the first journal, the authors have put emphasis on the use of capital budgeting in corporate
finance and how the development of capital asset discounting model (CAPM) has affected the
practice in Australia. The various issues are the extent of use of real options analysis instead of
discounted cash flow technique; using discount rates of varying time; the inputs used by the
companies while applying CAPM; what are the differences, in relation to the cost of capital,
between the regulatory practices and Australian corporate. The authors have further discussed
the various surveys done to reveal the growing recognition of the discounting cash flow (DCF)
technique and also the reliance place on the discounting rate which is considered to be the
weighted average cost of capital (Dumay & Baard, 2017). These surveys were done by
MacMohan (1981), Lilleyman (1984) and Hobbes (1991). The recent international surveys
conducted by Kester et al. (1999) on the Asian pacific countries which included various
Australian companies as well has disclosed that almost 73% of the companies which were
surveyed followed CAPM. There were various other surveys which were conducted to review
the importance of CAPM in various countries. The other areas which were looked upon were
the evaluation of the effects tax credits imputation. The surveyor has selected 488 firms which
were included in the All Ordinaries Index in August 2004 as the interested population. The main
focus of the survey was on the practice of capital budgeting by the Australian companies so the
companies outside the boundaries of Australia were excluded from the survey. The survey
included 20 questions and the response rate was 24.4 % and on the basis of revenue the
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average size of the respondents was $ 1.32 billion. The survey was inclined towards the large
firms as they were likely more participative in the survey. According to the survey on the
evaluation of the techniques used by the Australian companies, it was observed that the net
present value techniques were used by 82 numbers of companies which was 94 % of total
responses and while 11 companies forming 13% of the responses followed other techniques.
The authors have observed on the basis of various surveys that many companies did not place
full reliance on the single capital budgeting technique instead they were using various other
techniques along with it (Linden & Freeman, 2017). The techniques which topped the list of
techniques were NPV, IRR and Payback. The most popular method use in the estimation of the
cost of capital was the capital asset pricing model (CAPM). The authors have also presented
various tables and charts for the analysis of the above techniques used in capital budgeting. The
authors have also emphasized on the adjustments for Dividend Imputation Credits, which was
not done by the majority of the companies investigated. Nonetheless, the surveys discussed in
the journals and briefed as above are considered important for the updating of our knowledge
and practice.
The authors of the second journal have emphasized on the evaluation of the techniques used
currently in capital budget decision making in Canada. The authors have discussed the various
trends in the capital budgeting decision making process. There has been a long gap between
the studies done on the capital budgeting decision making process, which is around 50 years.
Discounting cash flows are not being involved in the various investment analysis methods by
the Canadian firms (Raiborn, et al., 2016). The authors have also pointed on the proper
utilization of the DCF technique since adoption of the same is the first step towards the
effectiveness of capital budgeting. The determination of cash flows was not proper in the
analysis of the capital investment by the Canadian firms. Moreover, the basis of the DCF
technique should be the cash flows and not accounting income. The firms are expecting
recognition of inflation in the capital budgeting decision making process. In the calculation of
DCF cost of capital has been considered as a key parameter. The firms generally make wrong
decision by choosing a single cost of funds. For the calculation of the cost of capital the weights
taken should be based on the market values of the firm’s capital structure rather than on the
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book values. However, in case of Canada there is no research investigating about the weights
used for the calculation of WACC. It has been observed that many large firms in Canada and US
as well have to face difficulty relating to separation of divisional cost of capital. For the effective
decisions in respect of capital investment, risk analysis is of great importance apart from the
DCF techniques, estimates of discount rate and proper cash flows. The literature also provides
for various recommendations about the administration apart from the use of proper financial
techniques. The authors have also discussed various surveys conducted in Canada presented in
the forms of tables and charts in great detail (Truong, et al., 2008). There were 17 firms which
did not use the DCF techniques out of the total number of 88 firms surveyed in Canada.
Nonetheless, the outcomes of these surveys have various limitations. The survey was restricted
to small number of the large firms in Canada because they apply DCF method in capital
budgeting technique. The managers of the companies considers internal rate of return (IRR) as
the key model of capital decision making in spite of the drawbacks faced in using this model
because it gauges the value of investment in the terms of percentage, which makes it easy for
them to compare various capital budgeting projects. For the evaluation of risks, we have
observed that most of the firms in Canada uses sensitivity analysis as the risk analysis tool, the
percentage of the firms using the sensitivity analysis being 92.8 % and those using scenario
analysis as the risk analysis toll being 85.3 %, while risk adjusted discount rate is being used by
76.8% firms as risk analysis tool. There has been a considerable increase in the sensitive analysis
and risk adjusted discount rate in the current period as compared to the past research.
Similarities and differences between the findings of the 2 studies
We have observed certain similarities between the above journals. These similarities are stated
below:
a) The authors of both the journals put emphasis on the capital budgeting technique and
different methods of applying the same.
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b) According to both the journals, the most widely use technique in the Capital budgeting
is the DCF technique.
There were certain differences between the above journals as well. These differences are
stated as follows:
a) The first journal discuss the capital budgeting decision making in case of Australian
companies while the second journal was on the discussion about the improvement in
the capital budgeting technique in Canada (Bennuona, et al., 2010).
b) In the first journal, primary emphasis was given on the estimation of cost of capital
while in the second journal the discussion was about enhancement in the capital
budgeting decision making.
Specific outcomes and relevant learnings from the research findings
From the first journal we have learned the following points which are discussed below:
a) The companies usually follow more than one technique instead of single capital
budgeting technique. Also in case of project evaluation the companies uses other
techniques like internal rate of return (IRR) and payback method apart from the usual
net present value (NPV) method.
b) The weighted average cost of capital (WACC) is commonly used as the discounting rate
by most of the companies across the boundaries. CAPM is used widely as the asset
pricing model for the estimation of the cost of capital.
c) The real options technique has also come up as a popular technique for the evaluation
of projects. Although the users of this technique are substantially minor and considered
as unimportant (Kewell & Linsley, 2017).
d) We have observed that while the companies acknowledges time varying as the nature of
risk, however in their risk evaluation techniques they use fixed discount rate.
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In case of the second journal, there were several points which grabbed our attention and we
would like to discuss the same. These points are mentioned as follows:
a) The discounting cash flow technique has been considered as the most recommended
technique of investment decision making process, which has also become the standard
technique. The employment of the non DCF techniques has decreased but is still
adopted by some firms.
b) Although the DCF techniques have been used widely but the improvement in this
technique has been restrained. There were many areas requiring more improvement in
investment decision making process (Zhou, 2018).
c) There were certain limitations which were observed like the confinement to one
country. However, this research has enhanced the knowledge relating to the capital
investment. This study helps in improving the usual problems faced in the use of DCF
techniques.
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