Definition of a Budget, Its Importance and Uses

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Table of Contents

Introduction
Weaknesses of the Annual Budget Model
Barriers Posed by the Traditional Budgeting Process
Activity Based Models
Reference List

Introduction

A budget is a planning instrument expressed in quantitative terms. It generally gives the costs incurred in a certain period and compares them to the revenues earned in that period. In a case where the revenues are more than the expenditures, the budget is a surplus budget. On the other hand, if the expenditures are more than the revenues, it is a deficit budget. Organizations use budgets as a tool for controlling expenditures, setting organizational goals, analyzing trends, and measuring performance. Previously, the annual budget model was more popular but because of the dynamic nature of the business environment, most organizations have adopted new models that cater to these changes. The traditional annual budget model only concentrates on the financial aspects of an organization (Sullivan et al. 2003).

This has become its greatest setback. This is because today’s businesses environment merges the financial aspects with the non-financial aspect of an organization. An example of the traditional models is the incremental model that uses figures from previous periods where the only thing that is done is to add certain amounts to those figures. Today’s models emphasize the fact that a business is more than the financial results it reports. It gives great importance to things like achieving efficiency in the organization, customer satisfaction, employee satisfaction, and motivation, and coming up with flexible strategies to beat off competition from other firms. It is with this background that we now delve into the inherent weaknesses that the annual budget model presents (Seal, Garrison, and Noreen, 2008).

Weaknesses of the Annual Budget Model

As mentioned above, the traditional budget model, due to its inherent weaknesses has become less efficient. The need for better budgeting has to lead to a movement from incremental budgeting to alternative budgeting approaches. Some of these weaknesses include; first, the annual budget model lacks flexibility (Tinnish, 2004). This means that organizations using this model face the problem of making adjustments to adapt to the changes in the business environment. The figures are normally determined beforehand and provide no room for adjustments (Kaplan and Cooper, 2009). That is, they are prepared in advance for use in the future.

This is a setback because for a company to be successful, it requires continuous improvements in its plans. Secondly, preparing the annual budget is time-consuming and requires a huge proportion of the organization’s resources. More often than not, the benefits derived are not directly proportional to the time and resources applied. This, therefore, leads to a waste of time and resources. These resources and time can be employed in other areas of the organization (Elliot and Elliot, 2004).

The third weakness is that annual budgets are less competitive in that they mainly focus on the internal operations of the organization. They completely ignore the external environment, which is equally important. An organization needs to keep a close eye on its external environment. This is the only way that it can ensure continued growth, efficiency, and survival. Another major weakness is that this type of budget is viewed to be complicated (Maskell and Baggaley, 2003).

It is complicated in the sense that it is expressed in financial terms that restrict understanding to those with a bit of accounting knowledge. It is also complicated in the sense that it makes it hard for management to carry out trend analysis due to its large number of figures. Finally, annual budgets slow down the decision-making process. This is because it uses a top-down approach and gives emphasis to bureaucracy (Sharman, 2003). The organization’s management makes decisions on what employees and low-level management can do, and how much they should use. Lower-level management is not usually empowered to make any decisions (Randall, 1999). This limits employee involvement hence making this model less efficient (Horngren, Sundem, and Schatzberg, 2010).

Barriers Posed by the Traditional Budgeting Process

The traditional budgeting process has many weaknesses as mentioned above. It is because of this that it is viewed as a barrier to the achievement of certain strategic changes. This especially refers to those strategic changes brought about by benchmarking, balanced scorecards, and activity-based models. These barriers will be discussed below:

Benchmarking

Benchmarking is the process whereby an organization sets its goals based on set standards. These standards are normally the practices and principles of another organization. This organization normally represents the best or the most successful organization in that particular industry. This however does not mean that an organization can only set its benchmarks based on its external environment.

An organization has the option of setting its benchmarks depending on its internal practices (Nokes, 2000). It merges the financial aspects and the non-financial aspects of an organization. Benchmarking advocates for flexibility and continuous improvements through frequent reviewing of other companies’ practices and strategies. It also uses the bottom-down approach that allows for the involvement of lower-level employees. It advocates for the continuous improvement of the organization. It also incorporates the external environment (Brotherton, 2008).

The traditional process, therefore, acts as a barrier in that it is not flexible and it does not create room for continuous improvement. It always uses the top-bottom approach that locks out low-level employees. In other words, it emphasizes the internal aspects of the organization, therefore, making it a complacent model (Jones, 2008).

Balanced Scorecard

Management uses the balanced scorecard to set both financial and non-financial goals. It incorporates four perspectives: the financial perspective, the internal perspective, customer satisfaction perspective and innovation and improvement perspective. It takes care of both the internal and external perspective of the organisation. Therefore, unlike the traditional process, it gives utmost importance to the other things that lead to the success of an organisation. For example, it ensures that customers remain satisfied while still making sure that its financial accounts remain healthy (Friedl et al. 2005).

The traditional budgeting process therefore acts as a barrier in that it does not support the philosophies of this model. For example, it only focuses on the financial aspects ignoring all other aspects. Unlike the balanced scorecard, it divides the different departments of an organisation. It also does not allow for the quick viewing of the factors both internal and external that affect the organisation (Carnal, 2007).

Activity Based Models

Activity based models are mainly concerned with the financial aspects and the aspects affecting the operations of the organisation. The main determinant of the budget is the activities carried out and not what management views as appropriate. It normally uses a bottom up approach where the operations managers are the ones that come up with the budget. Its biggest advantage is that it gives room for improvement (Brotherton, 2006).

It takes into account the fact that operations are prone to waste and that at any time the amount of work can increase. Activity-based models ensure that resources are used optimally, and give a detailed analysis of the costs. It also allows for transparency in that there are constant inspections (Weetman, 2007). The inspections are for the purposes of identifying wasteful processes and ensuring that resources are put into the best use that will result into optimal outputs. Activity based models also emphasize on the importance of the external aspects that affect the entire industry. Another crucial benefit is that it is not time consuming and neither does it use up a large amount of resources (Brimson, 2010).

The traditional budgeting process therefore compared to the activity-based models has its limitations. In the case of the use of the bottom up approach as advocated for by activity-based models, the traditional budgeting process promotes the use of top bottom approach (Friedlob et al. 1996. It therefore goes against the principles of the activity-based models. It also provides a barrier in that unlike the activity-based model, it only focuses on the financial aspects of the organisation. This makes it difficult for the organisation to adapt to the changes in the dynamic environment on time. In terms of flexibility, the traditional budgeting process is very rigid (Campbell, 1998).

Changing the requirements provided for in this model is difficult as it is very bureaucratic. It works on the assumption that there can be no wastes and the amount of work cannot increase abruptly. Compared to the activity-based models, the traditional methods are more time consuming and yield less benefits (Millmore, 2007). The traditional budgeting process is restrictive in that it does not promote transparency. It does not carry out auditing processes that would ensure that the wasteful activities are identified on time. Therefore, given all the issues discussed, it is evident that the traditional budgeting process cannot withstand today’s dynamic environment. In order to ensure their survival, organisations need to adapt alternative budgeting approaches (Betzig, 2006).

Reference List

Betzig, V. (2006) Professional Meeting Management. Dubuque, Iowa: Kendall/Hunt Publishing Company.

Brimson, J. A. (2010) Activity Accounting: An Activity-based Costing Approach. London: John Wiley and Sons.

Brotherton, B. (2006) International Hospitality Industry. Oxford: Butterworth Heinemann Publications.

Brotherton, B. (2008) International Hospitality Industry: Structure Characteristics and Issues. Oxford: Butterworth Heinemann.

Campbell, D. (1998) Organizations and Business Environment. Oxford: Legoprint.

Carnal, C. (2007) Managing Change in Organizations. Essex: Pearson Education.

Elliot, B. & Elliot, J. (2004) Financial Accounting and Reporting. London: Prentice Hall.

Friedl, G. et al. (2005) Relevance Added Combining ABC with German Cost Accounting. Strategic Finance, 1: 56–61.

Friedlob, G. et al. (1996) Understanding Balance Sheets. New York: Wiley.

Horngren, C. T., Sundem, G. L., & Schatzberg, J. (2010) Introduction to Management Accounting. London: Person Education.

Jones, M. (2008) Management Accounting: An Introduction. Chicago: John Wiley and Sons.

Kaplan, R. S., & Cooper, R. (2009) Cost and Effect: Using Integrated Cost Systems to Drive Profitability and Performance. London: Harvard Business School Press.

Maskell, T. & Baggaley, G. (2003) Practical Lean Accounting. New York, NY: Productivity Press.

Millmore, M. (2007) Strategic Human Resource Management: Contemporary Issues. Essex: Pearson Education.

Nokes, S. (2000) Taking Control of IT Costs. London: Financial Times / Prentice Hall.

Randall, S. (1999) Strategic Human Resource Management. Boston: MPG Books.

Seal, W., Garrison, R. H., & Noreen, E. (2008) Management Accounting. New York: McGraw-Hill.

Sharman, P. A. (2003) Bring On German Cost Accounting. Strategic Finance, 1: 2–9.

Sullivan, A. et al. (2003) Economics: Principles in Action. Upper Saddle River, New Jersey: Pearson Prentice Hall.

Tinnish, S. (2004) Break Ahead Budgeting. Tips for Innovative Meetings and Events. Suetinnish. Web.

Weetman, P. (2007) Financial and Management Accounting: An Introduction. Chicago: Prentice Hall.

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