CHAPTER 2 REVIEW OF RELATED LITERATURE AND STUDIES This chapter gives recognition to the concepts and theories of financial budget planning and control from different books and references which the researchers used to provide supplementary information. Review of related literature and studies, foreign and local was conducted for the achievement of the goals and completion of the study. Foreign Literature A budget is a quantitative expression of a plan for a defined period of time. It may include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. Budgeting practices are heavily influenced by the organization’s management style and can vary considerably, but the theory is common to all. Given the relationship between budgets and planning, readers might also like to refer to the Planning and Forecasting topic gateway. Budgeting is the process of expressing the predicted costs and resources for a planned course of action over a specified time period. Budgets can be drawn up for business units, departments, products, teams or the entire organization. Another term for a budget is a financial plan, but budgets can refer to non-cash resources, such as staff or time. Budgeting helps all types of organization to plan and control their operations, and to support their managerial strategies. A budget sets out the benchmark against which performance will be measured. For example, this might be the minimum profit and loss performance expected by senior management. Performance against budget may be part of the organization’s appraisal system for individuals who are deemed accountable for such performance. Therefore
budgets are a management tool, expressed in quantitative terms because this is the easiest way to prioritize and co-ordinate complex competing decisions throughout the organization. However, budgets may be dismissed as a ‘finance’ tool because they usually originate from the finance department and involve numbers. An unenlightened manager might undervalue their contribution. Budgets are often unpopular because of the time and effort spent on preparing and negotiating them, or explaining variances. Budgets can include financial indicators such as cash, profit/loss, working capital and non-financial items such as staff numbers, orders and volumes of output. Progress is monitored regularly (typically monthly) by comparing actual performance against budget. Here budget holders explain significant favorable or unfavorable variances. Budget variance is described as: The difference, for each cost or revenue element in a budget, between the budgeted amount and the actual cost or revenue. Where flexible budgeting is employed, it is the difference between the flexed budget and the actual value (http://www.cimaglobal.com. Retrieved September 10, 2013). Budgets are more commonly used in large companies which usually have formal and sophisticated budgetary systems. It does not mean however, that budgeting is applicable only to large firms. The use and importance of budgets in small companies should not be overlooked. Management consist of many activities, including making decisions, giving orders, establishing policies, providing work and rewards, and hiring people to carry out the abilities of the management.
This was true in many ways
organizations in the past. Alternatively, planning and control may be pushed into 17
the background and become almost invisible to line workers unless a major problem or failure occurs. Even which the planning effectively perform the basi9c functions of planning, organizing, and control management still must all three functions require participation by all management levels. Management set goals and objectives and formulate plans for achieving them. The expected financial impacts of plans are develop and evaluated through budgeting. Once plans are implemented, control depends heavily, or cost accounting, which provides management with reports of actual production cost, marketing expenses, and administrative expenses. Comparison of actual cost with those budgeted for control. The reasons for significant deviations are then determined a corrective actions are taken (Carter, 2007). The capital budgeting process consists of five distinct but interrelated steps: Proposal generation. Proposals for new investment projects are made at all levels within a business organization and are viewed a business organization and are reviewed by finance personnel. Proposals that are require large outlays are more carefully scrutinized than less costly ones; Review and analysis. Financial managers perform formal review and analysis to assess the merits of investment proposals; Decision Making. Firms typically delegate capital expenditures decision making on the basis of dollar limits. Generally, the board of directors must authorize expenditures beyond a certain amount. Often plant managers are given authority to make decisions necessary to keep the production line moving; Implementation. Following approval, expenditures are made and projects implemented. Expenditures for a large project often occur in phase; Follow up. Results are monitored and actual costs and benefits are
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compared with those that were expected. Action may be required if actual outcomes differ from project ones (Gitman & Zutter, 2012). Budgetary Control is the process of establishment of budgets relating to various activities and comparing the budgeted figures with the actual performance for arriving at deviations, if any. Accordingly, there cannot be budgetary control without budgets. Budgetary Control is a system which uses budgets as a means of planning and controlling. According to I.C.M.A. England Budgetary control is defined by Terminology as the establishment of budgets relating to the responsibilities of executives to the requirements of a policy and the continuous comparison of actual with the budgeted results, either to secure by individual actions the objectives of that policy or to provide a basis for its revision. Budget Control is a system of controlling costs which includes the preparation
of
budgets,
coordinating
the
department
and
establishing
responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability." The above definitions reveal the following essentials of budgetary control: (1) Establishment of objectives for each function and section of the organization. (2) Comparison of actual performance with budget. (3) Ascertainment of the causes for such deviations of actual from the budgeted performance. (4) Taking suitable corrective action from different available alternatives to achieve the desired objectives. When an entity or an individual undertakes a construction project, various accredited contractors are invited to bid for the project and the contract is awarded to the lowest bidder. Contractors on the other hand, prepare and estimate of the cost that will be incurred on the project so as to arrive at a 19
reasonable yet profitable bid price. For that reason, project planning is difficult challenge for managers. Project can be defined as “a series of related tasks directed toward a major output”. For companies with multiple large projects, such as construction firm, s project organization is an effective way o assigning the people and physical resources needed. It is temporary organization structure designed to achieve by using specialist from throughout the firm (Welsch, 2006). Project scheduling involves sequencing and allotting to all project activities. One popular project scheduling approach is the Gantt chart. Gantt chart is used to schedule resources and allocate time. They permit managers to observe the progress of cash activity and to spot and tackle problem areas. Gantt charts, though, do not adequately illustrate the interrelationships, between the activities and resources. Throughput, an important concept in operations, is the number of units processed through the facility sold. Throughput is a critical difference between the successful and the unsuccessful enterprise.
This has led to a focus of
constraints, which has been popularized by the book Goal: A process of ongoing improvement by Elihayu Goldratt and Jeff Cox. The Theory of Constraints (TOC) is a body of knowledge that deals with anything that limits and organizations ability to achieve its goals. Constraints can be physical or nonphysical (Heizer & Render, 2007). Management control system (MCS) is a system which gathers and uses information to evaluate the performance of different organizational resources like human, physical, financial and also the organization as a whole considering the organizational strategies Management control devices ensure that strategic intentions are achieved. Management Control Systems (MCS) is a systemized 20
accounting-based control of planning, monitoring, and performance-performance measurement, locked-in by the processes of strategic planning and operational control. As organizations evolve, a variety of procedures, planning requirements, budgetary policies, and operating guidelines are put in place in order to facilitate the control of operations. “The system of controls and the resulting management style within an organization can be an important inhibitor or facilitator of a firm's strategic initiatives”. There are developed five interdependent criteria, reflecting management choices: performance measurement, strategy, organizational structure, direction, and motivation. “The interdependence of the components is seen as a key factor in control system design. The understanding of the importance of any managerial activity within a control system is necessary for an effective MCS-design and implementation (Anthony and Govindarajan, 2007). A system of Internal Control extends beyond those matters which relate directly to the accounting and financial functions in an organization. Internal Controls may be either accounting or administrative in nature; distinction between accounting and administrative controls, however, will vary in individual circumstances. Accounting controls constitutes the company’s organizational plan, as well as its methods and procedures which are primarily designed to safeguard its assets and assure the reliability of its financial records. Example of accounting controls are the segregation of record-keeping from asset-custody functions, physical
controls
over
assets,
internal
auditing, and
authorization or approval of certain transactions.
21
requirements
for
Administrative controls usually relate only indirectly to financial records. They constitute the company’s organizational plan, methods and procedures which are primarily designed for operational efficiency and adherence to managerial policies. Examples of administrative controls are time and motion studies, quality controls, performance ratings, trainings programs and the like (Smith, Skousen & Kimwell, 2004). There are two issues traditional budget is faced with; the first issue is the accounting. The budget process serves two functions. It serves to build the internal budgets for each responsible center in the company and the roles up to form the external earnings per share capital. The problem with traditional budgeting is that it is based on general ledger (G/L). The G/L is the store house for the basic financial information of the company. That basic information is specifically direct revenue, direct expense and balance sheet amount s by centers. Many managers who get involved in the budget process generally only budget these amounts for the areas of their responsibility. Many of these managers have major profitability responsibility but never get to budget profitability. He further went to say that the internal accounting at most companies was based on expense allocations. This antiquated methodology is the underlying reason most management reporting systems are underutilized and one of the impediments to improving the budgeting process. Monopoly in market, it was seen from several respondents’ comments that they prefer to enter a market where they know that they can have a monopoly. In other words, companies, which knew that they would have a competitive and technological advantage over other players in the new market ventured into new 22
areas. This strategy also included targeting certain market segments where competition was less. Pursue one project, several respondents expressed that they preferred to target one particular project to enter a new market. During the execution of that project, the company understands the new market and the players in that particular region and later decides whether to continue working in the market or not. Some companies also follow their clients to new markets. Such entries are less risky for the companies. Join with local players, for some general contractors entering new markets, the players; the legal, regulatory and economic forces were new to them. To overcome these difficulties they teamed up with local players such as subcontractors, suppliers, and laborers or even went in for joint ventures. Establish good PR, many respondents expressed that good word of mouth and networking was important to stay in business. Individuals working in the marketing department did most of the service selling and were usually the first people to go to the new market. Some companies also indicated that over 50 % of the work was obtained through repeat clients thus highlighting the importance of relationship selling (Nolan, 2005). Local Literature Budget is a detailed plan defining or outlining the sourcing and uses of financial and other resources of the company in a given period of time. This is the plan expressed in a quantitative terms. Every organization or individual has to budget their scarce resources to make the best use of such resources (time, money and energy). Owners of successful small companies who survived and grew even in difficult economic times carefully planned or budget their inventory,
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purchases, expansion of facilities, and even financial transactions so that they do not over extend themselves and yet was able to meet customers’ needs. Developing a budget is a critical step in planning any economic step in planning any economic activity both profit oriented or not-for-profit oriented entities (Payongayong, 2006). A budget is a plan, expressed in quantitative terms, on how to acquire and use the resources of an entity during a certain period of time. A budget is a plan. And a plan may either be in a descriptive or quantitative form (Roque, 2011). Budgeting is the process of stating in quantitative terms their operations, usually in units and pesos and planned their organizational activities for a given period of time. Budgeting is the best approach to planning, controlling as well as cost reduction program of the company. The objectives of budgeting are it compels or forces managers to plan, it provides information that can use to improve decision making functions, it helps to set a benchmark that can be use for performance evaluation, and it improves communication and coordination. The major benefits of budgeting are: Budgeting compels managers to thin ahead by formulizing their responsibilities in business operations. Evaluating performances. Budgeting provides definite expectations that serve as the best framework for judging subsequent performance; Coordinating and control. Budgeting aids managers in coordinating their efforts, so that the objective of the organization as a whole matches the objectives of its parts; Motivation and positive behavior. People who are involved in preparation of the budget must develop a sense of commitments to the achievement of the budget they need.
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Likewise, promotions, incentives and rewards are based on job performance, which certainly the achievement of their targets. Planning is the process of translating the goals and objectives of the organization and developing a strategy in developing those goals in a systematic manner. Managers depend heavily on management accountants when planning is being prepared.
Goals are abstract achievements while, objectives are
desired quantifiable achievement for a period of time. These objectives must be logically desired results based on goals. Controlling is the process of setting performance standards, measuring performance, periodically comparing actual performance with standard, and taking corrective measures or actions when operations do not conform to what is expected. Managers must exert their best effort to achieve what was planned (Payongayong, 2006). Budgets are more commonly used in large companies which usually have formal and sophisticated budgetary systems. Most firms use budgets because they are aware of the advantages that may be derived from budgeting, among which are follows: Budgeting compels periodic planning. Through budgeting, the members of the organization are forced to plan on how to acquire and use the firm’s scarce resources. This results into a more efficient and effective utilization of such resources. Budgeting enhances coordination, cooperation and communication. Budgets prepared for the different segments of the organization are usually interrelated with each other. In the process of preparing such budgets, members of different organizational segments are enabled to exchange their ideas and objectives thereby giving them an opportunity to communicate with each other. 25
Budgeting forces quantification of plans and proposals. Budgets, as already mentioned are plans expressed in quantitative terms. Though it may be difficult to quantify all plans and business proposals, budgeting compels people in the organization to express their plans in terms of pesos and other units of measure to make them more meaningful and much easier to evaluate. Budgeting provides a framework for performance evaluation. Actual results if operations are compared with the budgeted figures to monitor the organization’s or the organizational segment’s performance. Any deviations of actual figures within the planned or budgeted amounts are noted, evaluated and investigated to determine the necessary corrective actions, if any. Deviations or variances also provide feedback information that is important in developing budgets for the succeeding budget period. Budgeting enables members of the organization to be aware of business costs. Ordinarily, only the accountants and financial executives are concerned about the cost implications of business activities and decisions. Other managers have their own areas of concern. During the budgeting process, however, these managers who are given participation in developing the budget become aware of the possible cost consequences of their planned activities, thereby allowing such managers to conduct a cost-benefit analysis of their own proposals. Budgeting satisfies some Legal and Contractual requirements. In some cases, budgets are prepared because the firm is required to do so. For instance, governments
agencies,
some
charitable
institutions
and
not-for-profit
organizations are required to prepared a budget and operate within such budget. Budgeting directs the firm’s activities toward the achievement of organizational goals. In the budgeting process, specific organizational goals for
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each segment, as well as the goals of the organization as well as a whole are formally established and incorporated in the budgets (Roque, 2011). Effective and efficient management of working capital improves returns and minimizes the risk that the business enterprise will run short of cash. By optimally managing cash, receivables, and inventory, a business enterprise can maximize its rate of return and minimize its liquidity and business risk. To improve cash inflow, you should evaluate the causes of and take corrective actions for delays in having cash receipts deposited. Ascertain the origin of cash receipts, how they are delivered, and how cash is transferred from outlying accounts to the main corporate accounts. Also investigate banking policy regarding availability of funds and the length of time lag between when a check is received and when it is deposited. The type of delays in processing checks are (1) “mail float,” the time required for a check to move from debtor to creditor; (2) “processing float” the time needed for the creditor to enter the payment; and (3) “deposit collection float,” the time it takes for a check to clear. There are many possible ways to accelerate cash receipts including the use of lockboxes, return envelopes, pre-authorized debits (PADs), wire transfers and depository transfer checks (Salvador, Baysa, Gamboa & Fua-Geronimo, 2012). Effective cash management requires controls to protect cash from loss through theft or fraud. The following are some characteristics of a system of cash control: Segregation of duties for handling cash and recording cash transaction. No one person should be in complete control of a transaction. The employee handling cash receipts should not have access to the accounting records for
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cash. This prevents simultaneous misappropriations and manipulating of accounting records to cover up stolen cash. Imprest System, which is characterized by daily deposit of all cash receipts intact in the bank and making disbursement through issuance of checks. This system prevents the presence of significant amount of cash balance within the business vicinity. Voucher system, which is a system to control the cash disbursements. Under the voucher system, properly approved vouchers, ensuring that all disbursements are authorized, support all cash payments. All potential payments are recorded first in the voucher register, and actual payments are recorded in the check register. Internal audits at irregular intervals. Cash counts are conducted without the previous notice to the cashier, such that the cashier is always conscious of his accountability, keeping the cash on hand intact. This may also involve test of checking of transactions and record keeping, which prevents convenience and manipulation of cash records (Robles & Empleo, 2010). Banks use different methods for the recognition and measurement of items in their financial statements. While harmonization of these methods is desirable, it is beyond the scope of this standard. In order to comply with IAS 1 presentation of financial statements and thereby enable users to understand the basis on which the financial statements of a banks are prepared, accounting policies dealing with the following items may need to disclosed: (1) the recognition of the principle types of income; (2) the valuation of investment dealing securities; (3) the distinction between those transactions and other events that result in the recognition of assets and liabilities on the balance sheet
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and those transactions and other events that only can give rise to contingencies and commitments; (4) the basis for the determination of impairment losses on loans and advances and writing off uncollectible loans and advances; (5) the basis for the determination of charges for general banking risks and the accounting treatment of such charges (Liz, Ruado & Domingo, 2013). Foreign Studies Budget preparation was carried out in the branches of the bank and that managers are the personnel responsible for the preparation and implementation of budget. It also revealed that the bank has a budget committee and that on the average budgets are actualized. Budget failure according to respondents was caused by poor implementation and forecasting. There was a significant relationship between budget and control mechanism in the banking industry and there was also a significant relationship between budget preparation and budget implementation in the banking industry (Abu-Saeed, 2008). Using data from management controllers or CFO, this research empirically investigates the reasons why companies implement budgetary control. Two theoretical frameworks are mobilized: contingency and neo- institutional theories. The contingency theory explains the implementation of the budgetary control by the search for technical efficiency. Indeed, the budgetary control allows “decentralization with coordinated control”, management by objectives and management by exception. For these reasons, it constitutes a useful tool in some “technical environment”. Five variables are used to operationalize the technical environment of organizations: environment uncertainty, complexity of the
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technology, organizational decentralization and strategy. For neo-institutionalist theory, the purpose of the budgetary control is not solely to improve technical efficiency of the organization, but also to give the illusion of rationality for internal and external actors and to legitimate the action of the organization. The budget thus responds to the expectations of the institutional and social environment of the organization. This institutional environment is characterized by the belonging to a parent corporation and the relationships with this parent, the type of shareholding and the functional background of the president of the organization. The empirical findings show that the neo-institutional framework is remarkably better at explaining the implementation of budgetary control than contingency framework. These results confirm the role of the budgetary control as a legitimating tool. It can thus be seen as a rational myth, i.e. as an institutionalized structure that gives the illusion of rationality (Adams, 2003). Companies use budgets for planning and controlling their operations. Therefore, budgets are an important tool for management in forecasting the future of a business. There are two main reasons for inaccuracy in a budget. One reason would be by error, the other by design. This study was concerned with budgetary slack, which was one of the causes of budgetary inaccuracy due to design. Cyert and March defined organizational slack as the difference between the resources available to the firm and the resources necessary to maintain the organization. Onsi stated that budgetary slack represents either the amount of additional resources managers purposely construct in the budget, or the amount by which they wittingly understate productive capability. Schiff and Lewin indicated that, through the process of understating revenues and overstating
30
costs, managers can create budgets with slack. It was generally assumed that budgetary slack was detrimental to organizations, but it also had been beneficial in certain instances. Schiff and Lewin discovered that management can and does create slack to achieve attainable budgets and to secure resources for furthering their personal goals and desires. They also stated that slack creation was universal with managers in companies that were profitable or non-profitable, stable or growing. They implied that it served management’s self-interest to have slack included in the budget (Ramdeen, Santos & Chatfield, 2007). Local Studies The concept of budgeting emphasizes the “total system” approach integrating all the functional operational elements of the entity. Therefore, wide level of participation at all management level should be attained. But, what is really difficult in the budgeting process is how to coordinate and reconcile the conflicting objectives of the different functional areas in the organization. Attempts are made through budget meetings to reconcile the different objectives and to coordinate them to maximize company operations towards the attainment of a common purpose (Cunanan, 2004) The perceived benefits of budgetary planning and controlling strategies when the respondents are grouped according to the size of the projects handled are very satisfactory. As the number of workers employed increases, the application of budgetary procedures become more frequent because large manpower resources needs more control as dealing with more manpower is more difficult that with lesser number of workers. The most important benefit brought by the budgetary planning and controlling strategies according to the nature of projects handed is that: “It 31
compels the management to give serious and timely attention to planning and instill in them the habit of careful study” (Peralta 2005). Budget process in the government which is similar to that in the private industries, mentioned the relevance of education as a basis for empowerment and that every person involved in the budget process and control procedures should have enough training and experience to carry out his functions effectively. The study also emphasized that decision making is one of the corner stone’s of an organizations life and that without the required knowledge, experience, and exposure in the assigned task, it cannot be carried out effectively (Abesamis, 2006). In accordance with the study of Casamina and Plazo (2011), company should make effort to make solutions and revisions when changes in budget occur. Conduct a review of the limitations of maintaining the budget planning and financial control against the benefits obtain. Moreover, continue innovating good budget planning skills and improvement on delegation of every responsibility to individuals. They should also continue to train and develop human resources. The company should promote full commitment and involvement of the employees as to budget planning and financial control and supporting and motivating the employees as they move toward excellence and improvement in their performance, and treat prior problems encountered in the budget planning and financial control with an effective good manufacturing practice. The researchers were able to relate studies made by Belleza, Bunyi, Noveras, Ramos, Raypan (2009) in emphasizing that it is functional to encourage the participation of members from each level of the organization. Furthermore, it suggested that annual team building activities be conducted to help build
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cooperativism and to avoid individualism within the group. Preparation of the budget to be structured was also pointed out to achieve a high probability of successfully attaining objectives. Time and effort differences should be considered in making up plans. Everyone uses the word budget as if it were an all cure for financial problems of an enterprise. However, a budget is simply a plan and specific management actions are needed to make it a reality. It is a planning document created before anticipated transaction occurs. If people want to make things happen, they have to plan. Once they have the plan, they are in better control of the inertia of the past and of the unknown forces of the future. But planning alone is not enough, control is also important. It is a process of comparing actual performance versus budget. These two represents the key features for the management to undertake “control by exception” (Caasi, 2005). Synthesis The related literature and studies just reviewed, provided guidelines and directions necessary to meet the desired objectives. Past researches provided findings and conclusions with the present researchers to correlate to their own study. In addition to that, some of the recommendations cited on the related studies are found to be associated and still applicable to the current study in spite the fact that they were conducted on different time frames. Though some of the materials cited above are not included in the scope of the study, it enabled the researchers to have firm background knowledge of the problem study. The present study is similar from the local study previously conducted by Casamina and Plazo (2011) entitled “Stressing the Budget Planning and Financial Control of Macro Liquid Petroleum Gas Co., Inc. This study confirms 33
that company should make effort to make solutions and revisions when changes in budget occur. Conduct a review of the limitations of maintaining the budget planning and financial control against the benefits obtain. Moreover, continue innovating good budget planning skills and improvement on delegation of every responsibility to individuals. Furthermore, both studies provide an understanding of the financial budget planning and control employed, the problems encountered and possible solutions to such, as well as the companies’ socio-economic and environmental contributions as viewed by the representatives of the respondent companies. The difference between the studies is the nature of business; the present study used bank while the past study used Oil Company as their subject. Another difference is that the present study focused on the financial budget planning. On the other hand, the previous study focused on both the operating and financial budget planning. The present study helps to confirm the facts that were presented in the literature and studies, both local and foreign, with regards to the financial budget planning and control of one’s business. The information given by the reference assists the researchers in conducting a study that would contribute to the existing body of knowledge about the topic.
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