Future of Budgeting
Introduction
The past decades have seen criticisms of budgeting techniques as management cost controlling systems. We have seen many writers mention about the widespread dissatisfaction with the bureaucratic exercise in cost-cutting that budgeting is accused of having become. Budgets are accused of being out of touch with the needs of the modern business and said of taking too long, costing too much and encouraging all sorts of perverse behaviour.
However, it is generally accepted that budgeting is a necessary evil, and that its benefits outweighed its costs.
A budget is not only a means of planning for various revenue streams, a control mechanism for an administration to keep from spending too much, a procedure for controlling its units, a process to coordinate the many activities that an institution undertakes, and a way to communicate to all stakeholders a summarization of the activities that the various units will undertake, but it is also a technique for setting the organization’s priorities by allocating scarce resources to those activities that officials deem to be the most important and rationing it to those areas deemed less vital. Following the priorities set in a budget is a key element in determining the direction of the organization and its future success or failure, which is why it should be based on a formal plan, such as a strategic plan, that the institution is supposed to be following.
Yet with all these problems and criticisms , research in organisations seems to suggest that this that traditional budgeting remains widespread. Some claim that as many as 99% of European companies have a budget in place and no intention of abandoning it (Kennedy and Dugdale 1999:22 quoted in Vuorinen , CIMA website).
For most companies budgeting is the accounting tool for planning and control and a central importance issue for companies. Budgeting are seen as essential for good management of companies. In some ways, this is true. In order for a strategy to succeed, it’s important for the various departments within a company to collaborate with each other, employing effective communication and efficient control.
According to Upchurch (1998), a budget is a quantified plan targeted at achievement of an organisation’s objectives. It is a form of management tool that stipulates the intended goals of an organisation and the direction to which all organisational activities must follow to achieve the set targets and also sets standards for performance measurement. Uyar (2009) adds that , Libby and Lindsay'" define the traditional budgeting process as it operates within the top-down (hierarchical) "command and control" model in which decisions, resources, and rewards flow down, while information flows back up as in Figure 1 below. They say that the role of line management is simply to operate the established facilities, systems, and personnel according to senior management's rules, regulations and pre-determined targets.
Steven adds that , Conventional budgeting is normally an incremental approach, which uses a company’s existing operations and current cost structure to determine budget costs. The starting point for this process is to obtain forecast costs for the current year. The next step is to make an adjustment to forecast costs based on budgeted output – eg, sales. The sales office budget includes an inflation adjustment, since the budget selling price has been increased in line with the expected rate of inflation.
Linn 2008 adds that a budget is just as important for nonprofit organizations, which by their nature are not required to maximize their profits, as it is for businesses, which exist to bring the utmost return on the stockholders’ investments
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Uses of budgets
As shown in Figure 1 , Organisations use budgets for different reasons. Most companies have historically seen budgeting as important due to their usefulness despite their deficiencies. They maybe used differently in different organisations but the fundamental goal by organisations is reducing costs and remaining competitive.
According to Linn 2007 , the advantages of traditional budgets include the fact that they are simple to preparation . Also by locking into place the decisions of the past, budgets guarantee that the units that won the budgetary battle when the incremental system was installed, whether because they were the most important to fund or received more than the deserved because of political influence, will continue to win in this budgetary process until the incremental system is replaced or side-stepped, either temporarily or permanently. This system, however, tends to create the least amount of conflict during the budgeting process because it just continues the status quo.
Performance measurement
Henderson 2003 explains that managers are responsible for carrying out plans and they are required to carry out specific tasks , manage staff and make necessary decisions. In this sense budgets help out assess success or failure in carrying out responsibilities. Drury (2008) adds that a variance analysis therefore indicates to senior management which areas need attention and this process can act as a control tool in turning their effort to areas that require more attention that is with the highest variances.
However , Financial results should not be used in isolation (Henderson 2003).
According to Ackoff (1981) the question here is whether budgeting helps motivate managers to perform better? First of all ideally by producing a budget, then managers have an indication how performance of the organization is perceived and the implication on what this have on the organization. So with this in mind, the managers have some sort of goal to achieve and if successful it could be argued that the manager has been successful in his role for the year.
firms compare actual to budgeted performance to determine promotions and bonuses. In this situation, employees have an incentive to understate performance (i.e., to set a low budget) because low targets are easier to achieve than high targets (
Allocation of resources
Even though most companies have long term plans, annual budgets assist in refining those goals. Due to the dynamic business environment, annual budgets help managers to adapt to changes in the business environment. Managers will therefore anticipate problems before they arise and thus resources are appropriated more strategically rather than on a spur of the moment basis. Weetman (1999)
Co-ordination of departmental goals
The budget acts in such a way to harmonise the various departmental plans of action. Managers may make decisions they think are in the interest of the organisation but all these plans need to be aligned with common goals delineated by budgets.
Henderson explains some managers might want larger empires and therefore request more staff. Some might want to develop particular areas of work which might be of personal interest. Some might be under pressure from suppliers to buy goods and services they don’t really need. These are examples of events that might happen which do not benefit the organisation. The budgeting process helps to influence this sort of behaviour.
Drury (2000) adds that budgeting forces managers to examine the relationships between their own operations and those of other departments to identify and resolve conflicts. Departmental differences are reconciled for the good of the organisation as a whole. Upchurch 1999 p452 explains that one of the objectives of budgets is thus to promote goal congruence. This helps to promote a synchronism between everyone within the organization. The intentions of managers are better known and unsatisfactory behaviour can be identified and rectified.
Communication tool
Henserson 2003 explains that budgeting as a communication mechanism involves senior managers briefing line managers and other employees about what is expected of them. Drury 2008 adds that the appropriate individuals are then made accountable for implementing the budget. It is not just the budget itself that facilitates communication , much of the vital information is communicated in the actual act of preparing it (Drury 2008)
Budgetary control conforms to the exception principle of management, which suggests that action need only to be taken when a predetermined plan is not achieved. (Bendrey et al, p80). This suggests that management should only take action when the actual performance is worse than that of budgeted for the period. Budgeting could be seen as system of authorization whereby the centralized authority who maintains cost and control the overall outgoing of the organization. This leads to system of hierarchy where it is from top to bottom.
Motivational tool
According to Bendrey (2003) budgets can be useful in influencing managers by motivating them to perform better to meet organisational objectives. The assumption here is that attempts will be made to achieve the organization’s objectives in return for rewards. This derives from motivation theory , which suggests that people have wants or desired outcomes and modify their behaviour accordingly (CIMA 2006).
In this sense , When used to evaluate and reward performance, budgets influence how much effort employees exert, as well as the allocation of this effort among company objectives (Fisher et al )??? Performance or moti?.
Budgets as control mechanisms
Budgets have a linkage with standard cost; a budget is related to an entire activity or operation, whereas a standard presents the same information on a per unit basis. A standard provides a detailed analysis to be made of the difference between the budgeted cost and actual cost, the detailed analysis is called variances. The accountant assists managers by pinpointing where the variances have arisen and the responsibility managers can undertake to carry out the appropriate investigations to identify the reasons for the variance. Hence, costs can be controlled more effectively. Budgets act as a system of manage and control (Drury 2008). Drury 2008 explains that budgeting enables managers to operate a system of management by exception. By comparing actual results with budget , management can ascertain which areas need attention. H adds that
Tight versus loose control
Merchant (1985b, 1998) defines a tight control system broadly as one that provides a high degree of certainty that employees act as the organization wishes. According to Merchant (1985b, 1998), tightening control systems can be done by:
(1) Definition of goals. Tightening control means defining goals such that they are more complete, more specific, and/or more congruent with organizational objectives. (2) Communication of goals. Tightening control means changing communication patterns in such a way that employees will better understand and accept organizational objectives. This may include communicating more effectively, timely, frequently, and convincingly.
(3) Monitoring. Tightening control involves more frequent, more detailed, and/or more timely monitoring of actions and/or results.
(4) Rewarding. Tightening control means enhancing the value of rewards to the employees evaluated and the definition of stricter relationships between rewards and performance.
In sum, tight budgetary control is held to exist if top management:
(1) Puts much emphasis on meeting the budget;
(2) Does not easily accept budget revisions during the year;
(3) Has a detailed interest in specific budget line-items;
(4) Does not lightly tolerate deviations from interim budget targets; and,
(5) Is intensively engaged in budget-related communications.(Van der Stede 2001).
Planning
According to Drury 2008 , the budgeting process ensures managers plan for the future and they consider how conditions in the next year might change and what steps they should take now to respond to these changed conditions. De With supports this by adding a budget can give early warnings of coming opportunities or threats. According to Huss (1977) , budgets help organisations convert goals into dollar amounts. By preparing a budget, organisations can determine in advance the financial effects of their decisions. In this respect , by promoting forward thinking budgets are said to allow management to have contingency plans in place if any potential problems were to surface (ref).
When used for planning decisions, information obtained during the budgeting process often is used to allocate scarce resources. Here, employees have an incentive to overstate budget numbers to acquire a larger share of the firm’s resources (Fisher et al 200 )
Conventional budgeting will provide accurate budget figures for variable cost such as direct materials, direct labour and sales commission, because these have a clear volume-based link with production/ sales. But this approach is unlikely to produce accurate figures for support departments, whose costs are largely fixed and semi-fixed and driven by other factors such as sales orders and purchase orders (ref).
According to Fisher et al 2007 Budgets also help elicit information from employees about local market conditions, anticipated product demand, and customer expectations. In turn, this information guides decisions about corporate strategy, pricing, product emphasis, and the distribution of scarce resources.
A recent study examined the accuracy of employees’ budget submissions when the firm used the budget both for planning and performance evaluation versus when the budget was used solely for performance evaluation.5 In this experiment, participants worked in groups of three, acting as either a manager or as one of two employees. All employees worked for three periods under a compensation arrangement that provided incentives for employees to set the budget significantly below their capabilities (i.e., to include slack). The researchers manipulated whether the budget was used for allocating resources between the two employees in addition to evaluating the performance of each employee. The results indicated that using budgets for both planning and performance evaluation virtually eliminated budget slack and increased employee performance by 25 percent (over employees whose budgets were only used to evaluate performance) (Fisher et al 2007). This study has several important implications. First, using budgets for both planning(resource allocation) and performance evaluation may yield better firm results by balancing competing motivations. This is because Using budgets only to allocate resources encourages employees to overstate the budget to meet a production goal or to complete a project. On the other hand, using budgets only for performance evaluation induces employees to understate projected performance to obtain targets that are easier to achieve. A second implication is that sharing information about budgets and performance among employees may increase their incentives to provide more accurate budgets. In essence, these findings demonstrate that a little competition goes a long way, highlighting the synergies created by using the same budget for planning and performance evaluation.
De With and Dijkman 2008 says that The last purpose of budgeting is authorization of spending. The budgetees are mandated to spend the approved budget amounts. In most cases, they are prohibited by higher management from exceeding the budget amounts
Criticisms of budgets
Professor Peter Horvath and Dr. Ralf Sauter of the Harvard Business School Paper stated that traditional budgeting is: “counterproductive, inefficient, rapidly becoming obsolete, does not motivate the right behaviours and is out of sync with strategy.”
Budgets are too time-consuming
Budgeting is seen as essential for companies. Large, billion pound companies spend on average 25,000 person days a year putting together a budget. (Gary, L 2003) However, in recent years, analysts and experts have questioned the effectiveness of the conventional process and have levelled charges against the technique:
Uyar (2009) One of the most prominent weaknesses of traditional budgeting is the time consumed by budget process. In providing concrete measure how much source consumes traditional budgeting, some estimates suggest that planning and budgeting processes use up to 20 per cent of all management time, and
25.000 person days are used per billion dollars of sales on planning and budgeting.'' Libby and Lindsay" support this view its well saying budgets take around four to five months to complete, and occupy up to 20 to M}% of senior executives' and financial managers' time.
However , Drury (2008) argues that the budget itself is not time consuming and expensive to put together, but the process of information gathering is the area that needs to be questioned. Data is as useful as the workforce that provide them so if data proves worthless, it is the data gathering process that comes into question and not the budgetary system. With information technology, accurate and quick information gathering process is enhanced saving time and cost. This therefore counters the claims made by critics of the system .
Uyar 2009 explains why traditional budgets fail by quoting Babbini who states that traditional budgets fail to measure the critical things that make organizations successful in today's fast paced, global economy. Those critical things that traditional budgets fail to measure, and that create shareholder value are customer loyalty, development of intellectual properties, speed to meet customer expectations, employee development, and product/service quality.
In order for management to prepare a concise and workable budget, time needs to be spent analysing past sales, forecasting demand and costs, as well as setting realistic targets and objectives. The problem arises with the degree of accuracy for the forecasting, as this is mainly subjective, it depends on the skills of the management and experience within their respective sector. To gather and organise the budget may take months, in some cases taking 20% of management time, added to the costs associated with its preparation. (Gary, L 2003)
In surveys of organisations taken on how traditional budgeting techniques fare, the response was overwhelmingly negative towards traditional budgeting. According to Beyond Budgeting Round Table (BBRT): · 75% said their processes can not cope with unpredictable change · 90% said they take too long and add too little value · 85% said they do not focus enough on key strategic issues · 75% said they cause dysfunctional, even unethical behaviour · 80% said they conflict with tools, such as the Balanced Scorecard.
Jeremy (2003) argued that the conventional budgeting process is it is unable to adapt to the fast changing environment. In a dynamic market, budgeting must integrate with and support business strategy. The conventional process is outdated in that it may assume a stable business environment and does not take into account the changing conditions quickly enough due to the centralised process, which is mainly fixed. Managers often have to wait until the results of their decisions are reported in the financial statements. By then, of course, it's too late to correct a financially undesirable decision.
In addition Samuelson (2003) found that Conventional budgeting processes also create a culture where managers and employees feel they must achieve the targets set out in the annual budget, even at the expense of quality. Managers feel pressurised to ensure their departments keep within the budget limits. Such imposed standards can create negative attitudes and result in demotivation and alienation. Incentive schemes rewarding managers and employees for achieving targets and keeping costs within budget may also create narrow thinking, in that employees may feel they cannot venture out of the set targets.
Budgets are rarely strategically focused and are often contradictory. According to a recent cover article in Fortune magazine, around 70% of budgeting companies surveyed were poor at executing strategy (BBRT 2008). Because a single budget can serve several purposes, sometimes the purposes do conflict, for example planning and motivation. Demanding budgets that may not be achieved maybe appropriate to motivate maximum performance but they are unsuitable for planning purposes.
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Source: BBRT 2008. Available from: http://www.bbrt.org/bbprob.htm
Acceded on 12 December 2010.
As a fixed performance contract – Shane (2005) argued that the budget as a fixed performance contract critic’s claim leads to budgetary gaming and unethical behaviour . Those responsible for the attainment of the budget may result into making budget targets easier to attain by negotiating for lower estimates or spending the entire resources allocated at the end of the budget end period in order not to lose the next entitlement, when setting the next budget. CIMA 2006 supports this view and adds that some managers go further to manipulate the actual cost if it seems that they will not be able to meet their budget, this practice would lead to fraud in the company (CIMA 2006) . Fisher et al For example, in a recent Harvard Business Review article, Michael Jensen argued that budget-based compensation contracts create an incentive for employees to lie to increase their pay. This will be discussed in more detail as a problem of participation.
Historical – Traditional budget according to critics is historical and backward looking instead of forward looking. Critics argue that previous year’s expenditure or figures may be irrelevant for future purposes due to dynamic nature of the business environment. According to Neely et al (2003) budgets may cause short term planning which may draw attention a way from the long term consequences. They focus on cost reduction rather than value creation and they strengthen vertical command and control
According to critics relying on previous data to set a current budget encourages in ward looking , short sightedness and only pays attention to achieving budgeted figures instead of implementing long term organisational strategy and maximisation of shareholders’ wealth.
Lack of strategic alignment and focus – according to Samuelson (2003) Traditional budget as a financial representation of an organisation only details the operational cash in flow and outflow without explicitly stipulating the mechanism for long term strategy implementation. Methods for pursuing organisational goals, how the organisation grows and develops over a course of time, what market to segment and adopt etc normally has to do with non financial drivers which are not dealt with by the traditional budgeting systems.
Inability to adapt to the business environment – The dynamic nature of the business environment mostly renders fixed budgets out of date. Budgets do not reflect the emerging network structures that organisations are adopting nowadays (CIMA 2006). Hope and Fraser (2003) argue that only 20% of companies change their budget within a year, a rigidity which is obsolete in a fast changing competitive environment. With rapid change and growth in information technology and changing customer needs, a fixed budget may act as a set back with allocation of resources fix.
With most fixed budgets remaining unchanged within the fiscal year Hope and Fraser (2000) opines that managers may fear to spend for fear of going over budget and this may result into inefficiency. According to Shane (2005) budgets fix plans for management to follow and this limits managers’ flexibility in responding to a dynamic business environment. Managers’ flexibility and ability to take advantage of new opportunities as and when it comes or handle threats and changing customer needs due to fear of going beyond budget stiffs innovation which is an impediment to organisational growth.
An evaluation of the claims of proponents and critics of traditional budgeting systems indicates that proponents of the traditional budgeting systems hold strong views and are not prepared to see the budgetary system abandoned as claimed by critics. However, the criticisms levelled at it are very valid. In terms of internal effectiveness to an organisation the traditional budgeting system is very efficient, however much cannot be said about external effectiveness.
The argument put forward by critics is that the traditional budgetary systems cannot respond quickly to the volatile external business environment. The uncertainty of the business environment is seen as the main reason for the diminishing role of the traditional budget. Uncertainties of the business environment render the traditional budgetary system obsolete according to Samuelson (1997 p109).
However to some extent the techniques of the traditional budgeting system can be seen as having played a major role in the creation of Zero base budgeting system. Due to the flexibility that is enhanced by the creation of the zero base budgetary systems, it can be argued that the budgets are capable of responding to the changing market environment. The view was supported by Lewis (1995) that the budget encourages systematic and gradual reaction to change instead of rapid and disorderly reaction to change.
Critics firmly have a case in questioning the amount of time involved and cumbersome nature of putting together a simple budget together; the cost is nowhere near the benefits.
The above discussions indicates that the budgeting is not a worthless activity as critics suggest. The budget is of relevance because it not only sets standards for monitoring organisational performance but also encourages unit level managers to think through every aspect of organisational activity in the budgetary process and enables managers to be in a better position to exploit opportunities. It also enables them to anticipate problems and take steps to eliminate or reduce their sensitivity or reduce their severity. As one observer said “few businesses plan to fail, but many of those that flop, failed to plan” (Horngren et al 1999 p486).
Even with these problems , most organisations can not do without budgets. Most are however introducing better budgeting techniques into their systems in an attempt to address and provide solutions to some of the problems of traditional budgeting mentioned above.
Better Budgeting.
Umar 2009 explains that due to limitations of traditional budgeting, both academicians and practitioners search for new budgeting methods that can aid to improve planning and budgeting processes. Better budgeting involves incremental improvements in traditional budgeting. CIMA 2004 explain further that with Better budgeting the fixed performance contract is supplemented by various tools to make it more flexible and dynamic.
Even with these problems, most companies still use traditional one year budgets. Research by Kennedy and Dugdale (1999) suggests that traditional budgeting remains widespread and most European countries had a budget in place and had no intention of abandoning it.
This literature will uncover five principal techniques and approaches that can aid improved budgeting and planning. These are 1. Activity based budgeting 2. Zero based budgeting 3. Value based management 4. Profit planning 5. Rolling forecasts and budgets
The first two help improve the focus and accuracy of budget outputs. They however , they tend to be more work than the traditional system , so at best they are used as one off technques rather than regular ones.3 and 4 appear to be theoretical approaches rather than adopted practice as very few examples of practical application and implementation exist. Also there is little evidence to suggest that they will simplify the budgeting process. The 5th approach appears to be the one with the most potential. A number of organisations have successfully implemented it to improve their forecast . These approaches , att best , are solutions to some of the problems discussed earlier of budgets.
Activity-based budgeting (ABB) – according to Lana (2002) Activity based budgeting involves planning and control along the lines of adding value to processes. This technique looks at a budget in terms of the costs associated with an organisation’s deliverables, products and services. The traditional approach describes cost factors in terms of their nominal values. ABB is adopted by the organisations that have implemented activity based costing (ABC). The aim of ABB is to authorise the supply resource that are needed to perform activities to meet budgeted production and sales volume. ABB provides a framework for understanding the amount of resource are required to achieve the budget level of activity. It can adjust the budget if resources are limited base on the amount of resources are required.
According to Plowman ABM helps managers to assess: • the true cost of making products, providing services and servicing customers • which products, services and customers are profitable and which are not • which resources can safely be cut, or re-deployed and made available for investment in new products and services • the level of resource required in future periods, to help predict and provide volumes of products and levels of customer service.
Zero Based Budgeting (ZBB) –.According to (Drury 2006) Zero based budgeting focus on programmes or activities, it requires all activities are justified and prioritised before resource allocated to each activity. No doubt, this approach for projected expenditure should start from zero, each year the budgets are set base on the assumption of programmes are introduced for the first time.
According to Linn the benefit of ZBB is that it points out those expenses that are no longer necessary, thus allowing the library to shift money to where it will be needed in the future.
According to Chan (2008) The ZBB process involves a cost and benefit analysis that aims to align closer the budget with program needs and objectives. It is a technique of planning and decisionmaking that emerged in the late 70's that requires managers to justify not only increases over previous year, but to entirely review objectives and function by defining costs and benefits and the most efficient ways to achieve.
Hope and Fraser (2004) argued that the process is so bureaucratic and time consuming that few companies uses it more than once. Linn supports this view adding that ZBB requires that every item be justified thereby taking a great deal of management time. This is why a much smaller number of organizations now use ZBB than did a few decades ago. Many that do still use it do so in conjunction with another system. When utilized in this way, ZBB is used in one part of the institution every year, but the unit that is doing the intense budgetary work rotates every year, so that any given unit has to do it only once every so many years.
However, it is suitable for non profit making organisation like local and government organisations. they period begins with a blank (zero) budget allowance and building on this over the period.
Hope and Fraser (2004) argued that the process is so bureaucratic and time consuming that few companies uses it more than once.
Performance-based budgeting (PBB)
This approach was formulated in the USA and was in response to US government regulations for its contractors according to Stokdyk (2007). This style of budgeting aims to allocate available resources on a goal basis and measurable results. In the article by Stokdyk (2007), John Mercer, reiterates that "A real performance budget gives a meaningful indication of how money is expected to turn into results."
Performance-based budgeting also introduces a ‘‘rule’’ that budgetary decisions should be made on the strength of previous performance, not accepted process (Andrews and Hill 2002). PBB reforms involve the introduction of new rules and norms to drive budgeting behavior, which have to overcome the influence of pre-existing rules and norms (usually associated with incremental and program budgeting systems) in order to influence behavior. In the clash with rules and norms of pre-existing budget approaches, unless PBB is actively implemented as a replacement for old budgeting ways (and not as a mere complement to them), the PBB rules and norms will be dominated (Andrew and Hill 2002)
rolling forecast budgets
According to Upchurch (1999) rolling forecast budgets will solve the problem of the budget period being fixed and outdated undermining their applicability in unstable environments. This helps the organisation to be prepared to adapt as necessary to market fluctuations, business cycles and external threats outside their control, especially a bear market.
Such rolling forecasts project recent actual figures 12-18 months there forth. When future forecasts are prepared for instance after three months, current actual figures are used as the base and the previous are dropped and the process repeats.
Another limitation is that this is based on estimation and subjective analysis of market conditions. Various assumptions may be made along the way of setting rolling forecasts. Although they will be more flexible and adaptable to setting annual forecasts, they still do not eliminate the systematic risk associated with estimations and predictions. Market trends may be prone to hard fluctuations, in order to account for that, a contingency plan will need to be developed by the organisation with the aim of dealing with abnormal changes in the corporate environment which would have a significant effect on sales.
If rolling forecasts are seen by senior managers as a tool for questioning or reassessing performance targets, they will be of little value and their preparation may not give the required benefits.
Rolling forecast will solve the problem of budget being static in that they can not be changed once approved. Zero based budgeting will avoid the incremental nature of budgets as budgets will be prepared from scratch. Most companies see participation as a move away from the top down structure where senior management set budgets and impose goals on the rest of the organisation. The idea is that if individuals participate in decision making, job satisfaction and motivation will increase. However, its effectiveness depends on management commitment and expertise. And there is always a temptation to introduce budgetary slack.
However, better budgeting does not provide long term solutions because it does not address the fundamental weaknesses of the traditional budgeting model. For example, poor strategic linkage, the problem that budgets are time consuming and costly. And most do not focus on customers but on reducing costs. In fact they often create more work and expense rather than less.
The problem is that these better budgeting techniques, most of them applicable in the beyond budgeting model for planning purposes are being used within the old traditional budgetary model. Especially to supplement the traditional budget for control purposes, and hence they do not add value.
According to a study by CIMA and ICAEW Part of the reason why budgeting practice was able to evolve is because it has been supported by new technology which has changed the way data is collected and stored in organisations. In some cases, enterprise-wide systems have increased both the speed and the accuracy of budgets and forecasts. ??? support this view
Participation in budgeting
Participation is sometimes seen as a way to better budgeting and motivation. The idea is that when individuals participate in decision making , they will be more satisfied in with their job and so they will be more productive. This derives from the human relations thinking about organisational behaviour and is also broadly in line with the goal theory of motivation (CIMA 2006).
Organisational structure is also important as managers in decentralised organisations perceive themselves to be participating more in the budgeting process and they are more satisfied by it more than managers in centralised organisations. In these centralised organisations , a lack of participation is seen as the most effective approach (CIMA 2006).
According to Winata and Mia , from an individual employee’s point of view, budgetary participation is the process of developing an individual’s mental and emotional feelings that provide them with ownership of their decisions. Such a feeling motivates individuals and encourages them to be creative and pro-active (Owen, 1987). Other researchers suggest budgetary participation allows managers to actively take part in the formulation of budgets that they are responsible to implement (Brownell, 1981, 1982;Mia, 1984; Maloney and Mia, 1998). This participation has a number of positive behavioural outcomes, such as improved motivation and job commitment, reduced stress and enhanced performance. Brownell and McInnes (1986), and Mia (1988), for instance, argue managers’ budgetary participation augments their motivation to better perform their jobs. Conversely, budgets with inadequate managerial participation (involvement) may cause dysfunctional behaviour, which may lead to anxiety, stress and low performance (Brown, 1995). Prior studies (Hopwood, 1976; Mia, 1988) indicate that budgetary participation yields benefits through a greater exchange of information, better coordination of activities and development of ‘team’ spirit. In addition, Shields and Young (1993) suggest budgetary participation allows subordinate managers to contribute their personal knowledge to budgeting
(Fisher et al 2007 )The researchers found that budgets set through a negotiation process were lower than budgets set unilaterally by the manager.
The researchers found that employees made lower budget proposals when their managers did not have accurate information about their performance capabilities and vice versa. This experiment also found that when employees and their managers agreed on the budget, employees put forth more effort in the task.
Conversely, when budget discussions broke down and the manager set the budget, employee motivation and performance were negatively impacted.
These studies provide insights into the value of a participative budgeting process and some considerations for ensuring that the process serves to motivate employees. First, participation can increase effort, but employee expectations need to be managed. Imposing a budget following a negotiation impasse can be worse than not soliciting employee participation at all.
Second, in the event that employees and their managers cannot reach agreement on the budget, managers need to be careful in communicating the budget. If employees perceive that their input was seriously considered in setting the budget, the budget can be an effective motivational tool. In addition, budget communications should emphasize that there will be more budget discussions in the future. Employees who expected future budget negotiations with the same manager were more cooperative and performed at a higher level—both in absolute terms and relative to their budgets—than employees who did not expect future negotiations.
Problems with Participation
1.Lack of commitment - Some managers dislike financial figures , some dislike a formality of a budget plan preferring more flexibility , some may see themselves as too busy or some may be dissatisfied with their jobs. Secondly , some managers lack of expertise , especially if they have not received adequate training . Also managers might not understand how to coordinate their plans with those of other departments(CIMA 2006).
2.Budget slack- is also another problem. This is the intentional overestimation and /or underestimation of revenue during budget setting (CIMA 2006). Managers may do this because they may look good if actual costs are less than budgeted and their bonuses may even depend on it. Also they would not want to be blamed for overspending. Managers may envisage budget padding as necessary to cover for unforeseen events or they just might fear some expense had been forgotten.
However , there are arguments why slack should be allowed. Quoted companies might want to achieve profit forecasts and maintain share prices. Some organisations might want to motivate budget holders and some might want to encourage innovation. Public sector organisations might have enough at the outset of the budget to provide services (CIMA 2006). In a survey , De With and Dijkman 2008 asked whether top management sometimes consciously allows slack in budgets of business units. Of the respondents, 70.7% stated that top management sometimes allows slack in the business units, and 17.1% regularly allow it.
De With and Dijkman 2008
Reasons for allowing slack
To relax cooperation between diverse business units that have mutual relations. 19.0% (8)
To make long-term growth possible, even if this harms short-term performance. 52.4% (22)
To stimulate managers of business units to carry out innovations. 42.9% (18)
To realize a long-term orientation of managers. 21.4% (9)
To be able to absorb environmental uncertainty. 73.8% (31)
To stimulate other goals next to financial performance, such as customer satisfaction and the quality of products/services. 33.3% (14)
Behavioural implications of budgeting
Interest in human behavioural factors at work in budgetary planning and control was stimulated by an article written by Chris Argyris in the 1950’s (Drury 2008). Argyris identified four issues
1. The budget is seen by management as a pressure devise used to force lazy employees to work harder. The intention of such pressure is to improve performance but the unfavourable reaction of subordinates against it seems to be at the core of the budget problem.
2. Accountants as budget men success is in finding of significant adverse variances and identifying the managers responsible. Therefore the success of a budget man is failure of a manager. This causes loss of interest and declining performance. The accountant on the other hand , fearful of of having his budget criticised by factory management obscures his budget and variance reporting , and deliberately makes it difficult to understand.
3. As the budget sets targets for each department , achieving the target becomes of paramount importance regardless of the effect this may have on other departments and the overall company objectives.
4. Budgets are used by management to express their character and patterns of leadership on subordinates. Subordinates , resentful of their leaders style blame the budget not the leader.
Dime Bank's Caplanson is in a similar situation. The banking company typically builds about 5% contingency for unanticipated items into the
IT budget, "But it is rare that we use , this contingency, and therefore [we] often come in below budget for the….by VR
Management styles
Hopwood identified three distinct supervisory styles
|Supervisory style |Hopwood says…. |
|Budget-constrained |The managers performance is primarily evaluated on the basis of |
| |his ability to continually meet the budget on a sort term basis. |
|Profit -conscious |The manger’s performance is evaluated on the basis of his ability |
| |to increase the general effectiveness of his unit’s operations in |
| |relation to the long-term purposes of the organisation. |
|Non-accounting |The budgetary information plays a relatively unimportant part in |
| |the superiors evaluation of the manager’s performance. |
de With, E, & Dijkman, 2008 add that budget- constrained is concerned with accounting measures. They also say that the profit-conscious any overspending of budgets is evaluated in relation to long term objectives of the firm. In the non-accounting style, as budgetary data play a minor role, while nonfinancial information is important in the managerial evaluation.
According to Lau and Buckland , work by Hopwood (1972) indicated that an inflexible approach in the use of accounting data for evaluate subordinates' performance was associated with subordinates" jobrelated tension and other dysfunctional behaviour .However , research by Otley (1978) , was unable to replicate these results. They continue adding that this led to a stream of studies has examined a variety of variables which could influence the relationships between performance evaluative styles and a variety of behavioural outcome variables.
According to CIMA ICAEW if the less centralised budgeting is to survive, it needs to be supported by a culture of trust and empowerment. But the difficulties of creating a system of accountability that isn’t plagued by blame and mistrust – as is frequently the case with budgeting – were openly acknowledged.
Commitment at the highest level is crucial to making changes to the process. However, the ever-shortening tenure of an average chief executive officer (CEO) was seen as more of a threat than an opportunity – a new CEO may be in the best position to make radical changes but he/she may be unwilling to try a new and perhaps more radical approach to performance management and put their reputation on the line (CIMA ICAEW).
Pay and reward structures were seen as by far the biggest influence on people’s motivation. Few of the companies had remuneration tied to achievement of budgetary targets – although this is recognised as common practice – acknowledging that it can result in dysfunctional behaviour. It can also lead to budgeting becoming a way of negotiating pay. Instead, in some companies, pay is deliberately linked to other targets.For senior executives, this can be total shareholder returns relative to peers (CIMA ICAEW)
The past decades have seen criticisms of budgeting techniques as management cost controlling systems. We have seen many writers mention about the widespread dissatisfaction with the bureaucratic exercise in cost-cutting that budgeting is accused of having become. Budgets are accused of being out of touch with the needs of the modern business and said of taking too long, costing too much and encouraging all sorts of perverse behaviour.
However, it is generally accepted that budgeting is a necessary evil, and that its benefits outweighed its costs.
A budget is not only a means of planning for various revenue streams, a control mechanism for an administration to keep from spending too much, a procedure for controlling its units, a process to coordinate the many activities that an institution undertakes, and a way to communicate to all stakeholders a summarization of the activities that the various units will undertake, but it is also a technique for setting the organization’s priorities by allocating scarce resources to those activities that officials deem to be the most important and rationing it to those areas deemed less vital. Following the priorities set in a budget is a key element in determining the direction of the organization and its future success or failure, which is why it should be based on a formal plan, such as a strategic plan, that the institution is supposed to be following.
Yet with all these problems and criticisms , research in organisations seems to suggest that this that traditional budgeting remains widespread. Some claim that as many as 99% of European companies have a budget in place and no intention of abandoning it (Kennedy and Dugdale 1999:22 quoted in Vuorinen , CIMA website).
For most companies budgeting is the accounting tool for planning and control and a central importance issue for companies. Budgeting are seen as essential for good management of companies. In some ways, this is true. In order for a strategy to succeed, it’s important for the various departments within a company to collaborate with each other, employing effective communication and efficient control.
According to Upchurch (1998), a budget is a quantified plan targeted at achievement of an organisation’s objectives. It is a form of management tool that stipulates the intended goals of an organisation and the direction to which all organisational activities must follow to achieve the set targets and also sets standards for performance measurement. Uyar (2009) adds that , Libby and Lindsay'" define the traditional budgeting process as it operates within the top-down (hierarchical) "command and control" model in which decisions, resources, and rewards flow down, while information flows back up as in Figure 1 below. They say that the role of line management is simply to operate the established facilities, systems, and personnel according to senior management's rules, regulations and pre-determined targets.
Steven adds that , Conventional budgeting is normally an incremental approach, which uses a company’s existing operations and current cost structure to determine budget costs. The starting point for this process is to obtain forecast costs for the current year. The next step is to make an adjustment to forecast costs based on budgeted output – eg, sales. The sales office budget includes an inflation adjustment, since the budget selling price has been increased in line with the expected rate of inflation.
Linn 2008 adds that a budget is just as important for nonprofit organizations, which by their nature are not required to maximize their profits, as it is for businesses, which exist to bring the utmost return on the stockholders’ investments
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Uses of budgets
As shown in Figure 1 , Organisations use budgets for different reasons. Most companies have historically seen budgeting as important due to their usefulness despite their deficiencies. They maybe used differently in different organisations but the fundamental goal by organisations is reducing costs and remaining competitive.
According to Linn 2007 , the advantages of traditional budgets include the fact that they are simple to preparation . Also by locking into place the decisions of the past, budgets guarantee that the units that won the budgetary battle when the incremental system was installed, whether because they were the most important to fund or received more than the deserved because of political influence, will continue to win in this budgetary process until the incremental system is replaced or side-stepped, either temporarily or permanently. This system, however, tends to create the least amount of conflict during the budgeting process because it just continues the status quo.
Performance measurement
Henderson 2003 explains that managers are responsible for carrying out plans and they are required to carry out specific tasks , manage staff and make necessary decisions. In this sense budgets help out assess success or failure in carrying out responsibilities. Drury (2008) adds that a variance analysis therefore indicates to senior management which areas need attention and this process can act as a control tool in turning their effort to areas that require more attention that is with the highest variances.
However , Financial results should not be used in isolation (Henderson 2003).
According to Ackoff (1981) the question here is whether budgeting helps motivate managers to perform better? First of all ideally by producing a budget, then managers have an indication how performance of the organization is perceived and the implication on what this have on the organization. So with this in mind, the managers have some sort of goal to achieve and if successful it could be argued that the manager has been successful in his role for the year.
firms compare actual to budgeted performance to determine promotions and bonuses. In this situation, employees have an incentive to understate performance (i.e., to set a low budget) because low targets are easier to achieve than high targets (
Allocation of resources
Even though most companies have long term plans, annual budgets assist in refining those goals. Due to the dynamic business environment, annual budgets help managers to adapt to changes in the business environment. Managers will therefore anticipate problems before they arise and thus resources are appropriated more strategically rather than on a spur of the moment basis. Weetman (1999)
Co-ordination of departmental goals
The budget acts in such a way to harmonise the various departmental plans of action. Managers may make decisions they think are in the interest of the organisation but all these plans need to be aligned with common goals delineated by budgets.
Henderson explains some managers might want larger empires and therefore request more staff. Some might want to develop particular areas of work which might be of personal interest. Some might be under pressure from suppliers to buy goods and services they don’t really need. These are examples of events that might happen which do not benefit the organisation. The budgeting process helps to influence this sort of behaviour.
Drury (2000) adds that budgeting forces managers to examine the relationships between their own operations and those of other departments to identify and resolve conflicts. Departmental differences are reconciled for the good of the organisation as a whole. Upchurch 1999 p452 explains that one of the objectives of budgets is thus to promote goal congruence. This helps to promote a synchronism between everyone within the organization. The intentions of managers are better known and unsatisfactory behaviour can be identified and rectified.
Communication tool
Henserson 2003 explains that budgeting as a communication mechanism involves senior managers briefing line managers and other employees about what is expected of them. Drury 2008 adds that the appropriate individuals are then made accountable for implementing the budget. It is not just the budget itself that facilitates communication , much of the vital information is communicated in the actual act of preparing it (Drury 2008)
Budgetary control conforms to the exception principle of management, which suggests that action need only to be taken when a predetermined plan is not achieved. (Bendrey et al, p80). This suggests that management should only take action when the actual performance is worse than that of budgeted for the period. Budgeting could be seen as system of authorization whereby the centralized authority who maintains cost and control the overall outgoing of the organization. This leads to system of hierarchy where it is from top to bottom.
Motivational tool
According to Bendrey (2003) budgets can be useful in influencing managers by motivating them to perform better to meet organisational objectives. The assumption here is that attempts will be made to achieve the organization’s objectives in return for rewards. This derives from motivation theory , which suggests that people have wants or desired outcomes and modify their behaviour accordingly (CIMA 2006).
In this sense , When used to evaluate and reward performance, budgets influence how much effort employees exert, as well as the allocation of this effort among company objectives (Fisher et al )??? Performance or moti?.
Budgets as control mechanisms
Budgets have a linkage with standard cost; a budget is related to an entire activity or operation, whereas a standard presents the same information on a per unit basis. A standard provides a detailed analysis to be made of the difference between the budgeted cost and actual cost, the detailed analysis is called variances. The accountant assists managers by pinpointing where the variances have arisen and the responsibility managers can undertake to carry out the appropriate investigations to identify the reasons for the variance. Hence, costs can be controlled more effectively. Budgets act as a system of manage and control (Drury 2008). Drury 2008 explains that budgeting enables managers to operate a system of management by exception. By comparing actual results with budget , management can ascertain which areas need attention. H adds that
Tight versus loose control
Merchant (1985b, 1998) defines a tight control system broadly as one that provides a high degree of certainty that employees act as the organization wishes. According to Merchant (1985b, 1998), tightening control systems can be done by:
(1) Definition of goals. Tightening control means defining goals such that they are more complete, more specific, and/or more congruent with organizational objectives. (2) Communication of goals. Tightening control means changing communication patterns in such a way that employees will better understand and accept organizational objectives. This may include communicating more effectively, timely, frequently, and convincingly.
(3) Monitoring. Tightening control involves more frequent, more detailed, and/or more timely monitoring of actions and/or results.
(4) Rewarding. Tightening control means enhancing the value of rewards to the employees evaluated and the definition of stricter relationships between rewards and performance.
In sum, tight budgetary control is held to exist if top management:
(1) Puts much emphasis on meeting the budget;
(2) Does not easily accept budget revisions during the year;
(3) Has a detailed interest in specific budget line-items;
(4) Does not lightly tolerate deviations from interim budget targets; and,
(5) Is intensively engaged in budget-related communications.(Van der Stede 2001).
Planning
According to Drury 2008 , the budgeting process ensures managers plan for the future and they consider how conditions in the next year might change and what steps they should take now to respond to these changed conditions. De With supports this by adding a budget can give early warnings of coming opportunities or threats. According to Huss (1977) , budgets help organisations convert goals into dollar amounts. By preparing a budget, organisations can determine in advance the financial effects of their decisions. In this respect , by promoting forward thinking budgets are said to allow management to have contingency plans in place if any potential problems were to surface (ref).
When used for planning decisions, information obtained during the budgeting process often is used to allocate scarce resources. Here, employees have an incentive to overstate budget numbers to acquire a larger share of the firm’s resources (Fisher et al 200 )
Conventional budgeting will provide accurate budget figures for variable cost such as direct materials, direct labour and sales commission, because these have a clear volume-based link with production/ sales. But this approach is unlikely to produce accurate figures for support departments, whose costs are largely fixed and semi-fixed and driven by other factors such as sales orders and purchase orders (ref).
According to Fisher et al 2007 Budgets also help elicit information from employees about local market conditions, anticipated product demand, and customer expectations. In turn, this information guides decisions about corporate strategy, pricing, product emphasis, and the distribution of scarce resources.
A recent study examined the accuracy of employees’ budget submissions when the firm used the budget both for planning and performance evaluation versus when the budget was used solely for performance evaluation.5 In this experiment, participants worked in groups of three, acting as either a manager or as one of two employees. All employees worked for three periods under a compensation arrangement that provided incentives for employees to set the budget significantly below their capabilities (i.e., to include slack). The researchers manipulated whether the budget was used for allocating resources between the two employees in addition to evaluating the performance of each employee. The results indicated that using budgets for both planning and performance evaluation virtually eliminated budget slack and increased employee performance by 25 percent (over employees whose budgets were only used to evaluate performance) (Fisher et al 2007). This study has several important implications. First, using budgets for both planning(resource allocation) and performance evaluation may yield better firm results by balancing competing motivations. This is because Using budgets only to allocate resources encourages employees to overstate the budget to meet a production goal or to complete a project. On the other hand, using budgets only for performance evaluation induces employees to understate projected performance to obtain targets that are easier to achieve. A second implication is that sharing information about budgets and performance among employees may increase their incentives to provide more accurate budgets. In essence, these findings demonstrate that a little competition goes a long way, highlighting the synergies created by using the same budget for planning and performance evaluation.
De With and Dijkman 2008 says that The last purpose of budgeting is authorization of spending. The budgetees are mandated to spend the approved budget amounts. In most cases, they are prohibited by higher management from exceeding the budget amounts
Criticisms of budgets
Professor Peter Horvath and Dr. Ralf Sauter of the Harvard Business School Paper stated that traditional budgeting is: “counterproductive, inefficient, rapidly becoming obsolete, does not motivate the right behaviours and is out of sync with strategy.”
Budgets are too time-consuming
Budgeting is seen as essential for companies. Large, billion pound companies spend on average 25,000 person days a year putting together a budget. (Gary, L 2003) However, in recent years, analysts and experts have questioned the effectiveness of the conventional process and have levelled charges against the technique:
Uyar (2009) One of the most prominent weaknesses of traditional budgeting is the time consumed by budget process. In providing concrete measure how much source consumes traditional budgeting, some estimates suggest that planning and budgeting processes use up to 20 per cent of all management time, and
25.000 person days are used per billion dollars of sales on planning and budgeting.'' Libby and Lindsay" support this view its well saying budgets take around four to five months to complete, and occupy up to 20 to M}% of senior executives' and financial managers' time.
However , Drury (2008) argues that the budget itself is not time consuming and expensive to put together, but the process of information gathering is the area that needs to be questioned. Data is as useful as the workforce that provide them so if data proves worthless, it is the data gathering process that comes into question and not the budgetary system. With information technology, accurate and quick information gathering process is enhanced saving time and cost. This therefore counters the claims made by critics of the system .
Uyar 2009 explains why traditional budgets fail by quoting Babbini who states that traditional budgets fail to measure the critical things that make organizations successful in today's fast paced, global economy. Those critical things that traditional budgets fail to measure, and that create shareholder value are customer loyalty, development of intellectual properties, speed to meet customer expectations, employee development, and product/service quality.
In order for management to prepare a concise and workable budget, time needs to be spent analysing past sales, forecasting demand and costs, as well as setting realistic targets and objectives. The problem arises with the degree of accuracy for the forecasting, as this is mainly subjective, it depends on the skills of the management and experience within their respective sector. To gather and organise the budget may take months, in some cases taking 20% of management time, added to the costs associated with its preparation. (Gary, L 2003)
In surveys of organisations taken on how traditional budgeting techniques fare, the response was overwhelmingly negative towards traditional budgeting. According to Beyond Budgeting Round Table (BBRT): · 75% said their processes can not cope with unpredictable change · 90% said they take too long and add too little value · 85% said they do not focus enough on key strategic issues · 75% said they cause dysfunctional, even unethical behaviour · 80% said they conflict with tools, such as the Balanced Scorecard.
Jeremy (2003) argued that the conventional budgeting process is it is unable to adapt to the fast changing environment. In a dynamic market, budgeting must integrate with and support business strategy. The conventional process is outdated in that it may assume a stable business environment and does not take into account the changing conditions quickly enough due to the centralised process, which is mainly fixed. Managers often have to wait until the results of their decisions are reported in the financial statements. By then, of course, it's too late to correct a financially undesirable decision.
In addition Samuelson (2003) found that Conventional budgeting processes also create a culture where managers and employees feel they must achieve the targets set out in the annual budget, even at the expense of quality. Managers feel pressurised to ensure their departments keep within the budget limits. Such imposed standards can create negative attitudes and result in demotivation and alienation. Incentive schemes rewarding managers and employees for achieving targets and keeping costs within budget may also create narrow thinking, in that employees may feel they cannot venture out of the set targets.
Budgets are rarely strategically focused and are often contradictory. According to a recent cover article in Fortune magazine, around 70% of budgeting companies surveyed were poor at executing strategy (BBRT 2008). Because a single budget can serve several purposes, sometimes the purposes do conflict, for example planning and motivation. Demanding budgets that may not be achieved maybe appropriate to motivate maximum performance but they are unsuitable for planning purposes.
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Source: BBRT 2008. Available from: http://www.bbrt.org/bbprob.htm
Acceded on 12 December 2010.
As a fixed performance contract – Shane (2005) argued that the budget as a fixed performance contract critic’s claim leads to budgetary gaming and unethical behaviour . Those responsible for the attainment of the budget may result into making budget targets easier to attain by negotiating for lower estimates or spending the entire resources allocated at the end of the budget end period in order not to lose the next entitlement, when setting the next budget. CIMA 2006 supports this view and adds that some managers go further to manipulate the actual cost if it seems that they will not be able to meet their budget, this practice would lead to fraud in the company (CIMA 2006) . Fisher et al For example, in a recent Harvard Business Review article, Michael Jensen argued that budget-based compensation contracts create an incentive for employees to lie to increase their pay. This will be discussed in more detail as a problem of participation.
Historical – Traditional budget according to critics is historical and backward looking instead of forward looking. Critics argue that previous year’s expenditure or figures may be irrelevant for future purposes due to dynamic nature of the business environment. According to Neely et al (2003) budgets may cause short term planning which may draw attention a way from the long term consequences. They focus on cost reduction rather than value creation and they strengthen vertical command and control
According to critics relying on previous data to set a current budget encourages in ward looking , short sightedness and only pays attention to achieving budgeted figures instead of implementing long term organisational strategy and maximisation of shareholders’ wealth.
Lack of strategic alignment and focus – according to Samuelson (2003) Traditional budget as a financial representation of an organisation only details the operational cash in flow and outflow without explicitly stipulating the mechanism for long term strategy implementation. Methods for pursuing organisational goals, how the organisation grows and develops over a course of time, what market to segment and adopt etc normally has to do with non financial drivers which are not dealt with by the traditional budgeting systems.
Inability to adapt to the business environment – The dynamic nature of the business environment mostly renders fixed budgets out of date. Budgets do not reflect the emerging network structures that organisations are adopting nowadays (CIMA 2006). Hope and Fraser (2003) argue that only 20% of companies change their budget within a year, a rigidity which is obsolete in a fast changing competitive environment. With rapid change and growth in information technology and changing customer needs, a fixed budget may act as a set back with allocation of resources fix.
With most fixed budgets remaining unchanged within the fiscal year Hope and Fraser (2000) opines that managers may fear to spend for fear of going over budget and this may result into inefficiency. According to Shane (2005) budgets fix plans for management to follow and this limits managers’ flexibility in responding to a dynamic business environment. Managers’ flexibility and ability to take advantage of new opportunities as and when it comes or handle threats and changing customer needs due to fear of going beyond budget stiffs innovation which is an impediment to organisational growth.
An evaluation of the claims of proponents and critics of traditional budgeting systems indicates that proponents of the traditional budgeting systems hold strong views and are not prepared to see the budgetary system abandoned as claimed by critics. However, the criticisms levelled at it are very valid. In terms of internal effectiveness to an organisation the traditional budgeting system is very efficient, however much cannot be said about external effectiveness.
The argument put forward by critics is that the traditional budgetary systems cannot respond quickly to the volatile external business environment. The uncertainty of the business environment is seen as the main reason for the diminishing role of the traditional budget. Uncertainties of the business environment render the traditional budgetary system obsolete according to Samuelson (1997 p109).
However to some extent the techniques of the traditional budgeting system can be seen as having played a major role in the creation of Zero base budgeting system. Due to the flexibility that is enhanced by the creation of the zero base budgetary systems, it can be argued that the budgets are capable of responding to the changing market environment. The view was supported by Lewis (1995) that the budget encourages systematic and gradual reaction to change instead of rapid and disorderly reaction to change.
Critics firmly have a case in questioning the amount of time involved and cumbersome nature of putting together a simple budget together; the cost is nowhere near the benefits.
The above discussions indicates that the budgeting is not a worthless activity as critics suggest. The budget is of relevance because it not only sets standards for monitoring organisational performance but also encourages unit level managers to think through every aspect of organisational activity in the budgetary process and enables managers to be in a better position to exploit opportunities. It also enables them to anticipate problems and take steps to eliminate or reduce their sensitivity or reduce their severity. As one observer said “few businesses plan to fail, but many of those that flop, failed to plan” (Horngren et al 1999 p486).
Even with these problems , most organisations can not do without budgets. Most are however introducing better budgeting techniques into their systems in an attempt to address and provide solutions to some of the problems of traditional budgeting mentioned above.
Better Budgeting.
Umar 2009 explains that due to limitations of traditional budgeting, both academicians and practitioners search for new budgeting methods that can aid to improve planning and budgeting processes. Better budgeting involves incremental improvements in traditional budgeting. CIMA 2004 explain further that with Better budgeting the fixed performance contract is supplemented by various tools to make it more flexible and dynamic.
Even with these problems, most companies still use traditional one year budgets. Research by Kennedy and Dugdale (1999) suggests that traditional budgeting remains widespread and most European countries had a budget in place and had no intention of abandoning it.
This literature will uncover five principal techniques and approaches that can aid improved budgeting and planning. These are 1. Activity based budgeting 2. Zero based budgeting 3. Value based management 4. Profit planning 5. Rolling forecasts and budgets
The first two help improve the focus and accuracy of budget outputs. They however , they tend to be more work than the traditional system , so at best they are used as one off technques rather than regular ones.3 and 4 appear to be theoretical approaches rather than adopted practice as very few examples of practical application and implementation exist. Also there is little evidence to suggest that they will simplify the budgeting process. The 5th approach appears to be the one with the most potential. A number of organisations have successfully implemented it to improve their forecast . These approaches , att best , are solutions to some of the problems discussed earlier of budgets.
Activity-based budgeting (ABB) – according to Lana (2002) Activity based budgeting involves planning and control along the lines of adding value to processes. This technique looks at a budget in terms of the costs associated with an organisation’s deliverables, products and services. The traditional approach describes cost factors in terms of their nominal values. ABB is adopted by the organisations that have implemented activity based costing (ABC). The aim of ABB is to authorise the supply resource that are needed to perform activities to meet budgeted production and sales volume. ABB provides a framework for understanding the amount of resource are required to achieve the budget level of activity. It can adjust the budget if resources are limited base on the amount of resources are required.
According to Plowman ABM helps managers to assess: • the true cost of making products, providing services and servicing customers • which products, services and customers are profitable and which are not • which resources can safely be cut, or re-deployed and made available for investment in new products and services • the level of resource required in future periods, to help predict and provide volumes of products and levels of customer service.
Zero Based Budgeting (ZBB) –.According to (Drury 2006) Zero based budgeting focus on programmes or activities, it requires all activities are justified and prioritised before resource allocated to each activity. No doubt, this approach for projected expenditure should start from zero, each year the budgets are set base on the assumption of programmes are introduced for the first time.
According to Linn the benefit of ZBB is that it points out those expenses that are no longer necessary, thus allowing the library to shift money to where it will be needed in the future.
According to Chan (2008) The ZBB process involves a cost and benefit analysis that aims to align closer the budget with program needs and objectives. It is a technique of planning and decisionmaking that emerged in the late 70's that requires managers to justify not only increases over previous year, but to entirely review objectives and function by defining costs and benefits and the most efficient ways to achieve.
Hope and Fraser (2004) argued that the process is so bureaucratic and time consuming that few companies uses it more than once. Linn supports this view adding that ZBB requires that every item be justified thereby taking a great deal of management time. This is why a much smaller number of organizations now use ZBB than did a few decades ago. Many that do still use it do so in conjunction with another system. When utilized in this way, ZBB is used in one part of the institution every year, but the unit that is doing the intense budgetary work rotates every year, so that any given unit has to do it only once every so many years.
However, it is suitable for non profit making organisation like local and government organisations. they period begins with a blank (zero) budget allowance and building on this over the period.
Hope and Fraser (2004) argued that the process is so bureaucratic and time consuming that few companies uses it more than once.
Performance-based budgeting (PBB)
This approach was formulated in the USA and was in response to US government regulations for its contractors according to Stokdyk (2007). This style of budgeting aims to allocate available resources on a goal basis and measurable results. In the article by Stokdyk (2007), John Mercer, reiterates that "A real performance budget gives a meaningful indication of how money is expected to turn into results."
Performance-based budgeting also introduces a ‘‘rule’’ that budgetary decisions should be made on the strength of previous performance, not accepted process (Andrews and Hill 2002). PBB reforms involve the introduction of new rules and norms to drive budgeting behavior, which have to overcome the influence of pre-existing rules and norms (usually associated with incremental and program budgeting systems) in order to influence behavior. In the clash with rules and norms of pre-existing budget approaches, unless PBB is actively implemented as a replacement for old budgeting ways (and not as a mere complement to them), the PBB rules and norms will be dominated (Andrew and Hill 2002)
rolling forecast budgets
According to Upchurch (1999) rolling forecast budgets will solve the problem of the budget period being fixed and outdated undermining their applicability in unstable environments. This helps the organisation to be prepared to adapt as necessary to market fluctuations, business cycles and external threats outside their control, especially a bear market.
Such rolling forecasts project recent actual figures 12-18 months there forth. When future forecasts are prepared for instance after three months, current actual figures are used as the base and the previous are dropped and the process repeats.
Another limitation is that this is based on estimation and subjective analysis of market conditions. Various assumptions may be made along the way of setting rolling forecasts. Although they will be more flexible and adaptable to setting annual forecasts, they still do not eliminate the systematic risk associated with estimations and predictions. Market trends may be prone to hard fluctuations, in order to account for that, a contingency plan will need to be developed by the organisation with the aim of dealing with abnormal changes in the corporate environment which would have a significant effect on sales.
If rolling forecasts are seen by senior managers as a tool for questioning or reassessing performance targets, they will be of little value and their preparation may not give the required benefits.
Rolling forecast will solve the problem of budget being static in that they can not be changed once approved. Zero based budgeting will avoid the incremental nature of budgets as budgets will be prepared from scratch. Most companies see participation as a move away from the top down structure where senior management set budgets and impose goals on the rest of the organisation. The idea is that if individuals participate in decision making, job satisfaction and motivation will increase. However, its effectiveness depends on management commitment and expertise. And there is always a temptation to introduce budgetary slack.
However, better budgeting does not provide long term solutions because it does not address the fundamental weaknesses of the traditional budgeting model. For example, poor strategic linkage, the problem that budgets are time consuming and costly. And most do not focus on customers but on reducing costs. In fact they often create more work and expense rather than less.
The problem is that these better budgeting techniques, most of them applicable in the beyond budgeting model for planning purposes are being used within the old traditional budgetary model. Especially to supplement the traditional budget for control purposes, and hence they do not add value.
According to a study by CIMA and ICAEW Part of the reason why budgeting practice was able to evolve is because it has been supported by new technology which has changed the way data is collected and stored in organisations. In some cases, enterprise-wide systems have increased both the speed and the accuracy of budgets and forecasts. ??? support this view
Participation in budgeting
Participation is sometimes seen as a way to better budgeting and motivation. The idea is that when individuals participate in decision making , they will be more satisfied in with their job and so they will be more productive. This derives from the human relations thinking about organisational behaviour and is also broadly in line with the goal theory of motivation (CIMA 2006).
Organisational structure is also important as managers in decentralised organisations perceive themselves to be participating more in the budgeting process and they are more satisfied by it more than managers in centralised organisations. In these centralised organisations , a lack of participation is seen as the most effective approach (CIMA 2006).
According to Winata and Mia , from an individual employee’s point of view, budgetary participation is the process of developing an individual’s mental and emotional feelings that provide them with ownership of their decisions. Such a feeling motivates individuals and encourages them to be creative and pro-active (Owen, 1987). Other researchers suggest budgetary participation allows managers to actively take part in the formulation of budgets that they are responsible to implement (Brownell, 1981, 1982;Mia, 1984; Maloney and Mia, 1998). This participation has a number of positive behavioural outcomes, such as improved motivation and job commitment, reduced stress and enhanced performance. Brownell and McInnes (1986), and Mia (1988), for instance, argue managers’ budgetary participation augments their motivation to better perform their jobs. Conversely, budgets with inadequate managerial participation (involvement) may cause dysfunctional behaviour, which may lead to anxiety, stress and low performance (Brown, 1995). Prior studies (Hopwood, 1976; Mia, 1988) indicate that budgetary participation yields benefits through a greater exchange of information, better coordination of activities and development of ‘team’ spirit. In addition, Shields and Young (1993) suggest budgetary participation allows subordinate managers to contribute their personal knowledge to budgeting
(Fisher et al 2007 )The researchers found that budgets set through a negotiation process were lower than budgets set unilaterally by the manager.
The researchers found that employees made lower budget proposals when their managers did not have accurate information about their performance capabilities and vice versa. This experiment also found that when employees and their managers agreed on the budget, employees put forth more effort in the task.
Conversely, when budget discussions broke down and the manager set the budget, employee motivation and performance were negatively impacted.
These studies provide insights into the value of a participative budgeting process and some considerations for ensuring that the process serves to motivate employees. First, participation can increase effort, but employee expectations need to be managed. Imposing a budget following a negotiation impasse can be worse than not soliciting employee participation at all.
Second, in the event that employees and their managers cannot reach agreement on the budget, managers need to be careful in communicating the budget. If employees perceive that their input was seriously considered in setting the budget, the budget can be an effective motivational tool. In addition, budget communications should emphasize that there will be more budget discussions in the future. Employees who expected future budget negotiations with the same manager were more cooperative and performed at a higher level—both in absolute terms and relative to their budgets—than employees who did not expect future negotiations.
Problems with Participation
1.Lack of commitment - Some managers dislike financial figures , some dislike a formality of a budget plan preferring more flexibility , some may see themselves as too busy or some may be dissatisfied with their jobs. Secondly , some managers lack of expertise , especially if they have not received adequate training . Also managers might not understand how to coordinate their plans with those of other departments(CIMA 2006).
2.Budget slack- is also another problem. This is the intentional overestimation and /or underestimation of revenue during budget setting (CIMA 2006). Managers may do this because they may look good if actual costs are less than budgeted and their bonuses may even depend on it. Also they would not want to be blamed for overspending. Managers may envisage budget padding as necessary to cover for unforeseen events or they just might fear some expense had been forgotten.
However , there are arguments why slack should be allowed. Quoted companies might want to achieve profit forecasts and maintain share prices. Some organisations might want to motivate budget holders and some might want to encourage innovation. Public sector organisations might have enough at the outset of the budget to provide services (CIMA 2006). In a survey , De With and Dijkman 2008 asked whether top management sometimes consciously allows slack in budgets of business units. Of the respondents, 70.7% stated that top management sometimes allows slack in the business units, and 17.1% regularly allow it.
De With and Dijkman 2008
Reasons for allowing slack
To relax cooperation between diverse business units that have mutual relations. 19.0% (8)
To make long-term growth possible, even if this harms short-term performance. 52.4% (22)
To stimulate managers of business units to carry out innovations. 42.9% (18)
To realize a long-term orientation of managers. 21.4% (9)
To be able to absorb environmental uncertainty. 73.8% (31)
To stimulate other goals next to financial performance, such as customer satisfaction and the quality of products/services. 33.3% (14)
Behavioural implications of budgeting
Interest in human behavioural factors at work in budgetary planning and control was stimulated by an article written by Chris Argyris in the 1950’s (Drury 2008). Argyris identified four issues
1. The budget is seen by management as a pressure devise used to force lazy employees to work harder. The intention of such pressure is to improve performance but the unfavourable reaction of subordinates against it seems to be at the core of the budget problem.
2. Accountants as budget men success is in finding of significant adverse variances and identifying the managers responsible. Therefore the success of a budget man is failure of a manager. This causes loss of interest and declining performance. The accountant on the other hand , fearful of of having his budget criticised by factory management obscures his budget and variance reporting , and deliberately makes it difficult to understand.
3. As the budget sets targets for each department , achieving the target becomes of paramount importance regardless of the effect this may have on other departments and the overall company objectives.
4. Budgets are used by management to express their character and patterns of leadership on subordinates. Subordinates , resentful of their leaders style blame the budget not the leader.
Dime Bank's Caplanson is in a similar situation. The banking company typically builds about 5% contingency for unanticipated items into the
IT budget, "But it is rare that we use , this contingency, and therefore [we] often come in below budget for the….by VR
Management styles
Hopwood identified three distinct supervisory styles
|Supervisory style |Hopwood says…. |
|Budget-constrained |The managers performance is primarily evaluated on the basis of |
| |his ability to continually meet the budget on a sort term basis. |
|Profit -conscious |The manger’s performance is evaluated on the basis of his ability |
| |to increase the general effectiveness of his unit’s operations in |
| |relation to the long-term purposes of the organisation. |
|Non-accounting |The budgetary information plays a relatively unimportant part in |
| |the superiors evaluation of the manager’s performance. |
de With, E, & Dijkman, 2008 add that budget- constrained is concerned with accounting measures. They also say that the profit-conscious any overspending of budgets is evaluated in relation to long term objectives of the firm. In the non-accounting style, as budgetary data play a minor role, while nonfinancial information is important in the managerial evaluation.
According to Lau and Buckland , work by Hopwood (1972) indicated that an inflexible approach in the use of accounting data for evaluate subordinates' performance was associated with subordinates" jobrelated tension and other dysfunctional behaviour .However , research by Otley (1978) , was unable to replicate these results. They continue adding that this led to a stream of studies has examined a variety of variables which could influence the relationships between performance evaluative styles and a variety of behavioural outcome variables.
According to CIMA ICAEW if the less centralised budgeting is to survive, it needs to be supported by a culture of trust and empowerment. But the difficulties of creating a system of accountability that isn’t plagued by blame and mistrust – as is frequently the case with budgeting – were openly acknowledged.
Commitment at the highest level is crucial to making changes to the process. However, the ever-shortening tenure of an average chief executive officer (CEO) was seen as more of a threat than an opportunity – a new CEO may be in the best position to make radical changes but he/she may be unwilling to try a new and perhaps more radical approach to performance management and put their reputation on the line (CIMA ICAEW).
Pay and reward structures were seen as by far the biggest influence on people’s motivation. Few of the companies had remuneration tied to achievement of budgetary targets – although this is recognised as common practice – acknowledging that it can result in dysfunctional behaviour. It can also lead to budgeting becoming a way of negotiating pay. Instead, in some companies, pay is deliberately linked to other targets.For senior executives, this can be total shareholder returns relative to peers (CIMA ICAEW)
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