Budgeting Process Conceptual Study

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Introduction

Better budgeting in recent years may have been seen as a movement from ‘incremental budgeting’ to alternative budgeting approaches. However, academic studies e.g., Beyond Budgeting – Hope & Fraser etc. argue that the annual budget model may be seen as having a number of inherent weaknesses and also acting as a barrier to the effective implementation of alternative models for use in the accomplishment of strategic change. The traditional budgeting model was established in 1920 to help organizations in controlling their costs. The reason behind the development of the traditional budgeting model was thus to control the costs which it did reasonably well for a couple of years. Traditional budgeting has played an important role in budgeting over the years but it has proved to be more unsuitable with regards to modern business (Scarlet, 2006, 257). The purpose of this essay is to examine the inherent weaknesses of the annual budget model. The essay also discusses ways in which the traditional budgeting process may be seen as a barrier to the achievement of the aims of each of the following models for the implementation of strategic change i.e. benchmarking, balanced scorecard and activity-based models. However, it is important to first define the meaning of the term budget and traditional budgeting. A budget refers to a plan that is usually expressed in financial terms and extends to a future period of time. Budgeting entails the process by which organizations make short term plans once the strategic plans have been made so as to meet the laid down strategic objectives.

The inherent weaknesses of the annual budget model

The following are the inherent weaknesses of the annual budget model; traditional budgets are usually based on a fiscal year and thus there is not enough time for budget considerations. The traditional budgeting process is inefficient since it consumes much time and also it involves a lot of staff members which is costly. The main reason why the traditional budgeting process is very costly and time-consuming is that all the responsibility centres are required to be engaged in the traditional budgeting process. The time-consuming aspect of the traditional budgeting process implies that forecasts might be outdated before even the entire budgeting process is done. Organizational politics usually affects the traditional budgeting process making it to be unproductive. The traditional budgeting process spends a bigger percentage of the management time, estimated to be about 24% of the available time. Usually, the traditional budgeting process is developed and restructured regularly i.e. on annual basis and this makes it to be costly and time-consuming. The traditional budgetary process may lead to dysfunctional behaviours because it is not based on facts but assumptions which make it inefficient. Furthermore, the traditional budgeting process is usually unstable as far as changes in markets are concerned i.e. traditional budgeting process does not take into account the reality of market changes. This is dangerous since it can break down the relationships with key business partners. The time-consuming aspect of the traditional budgeting model has the effect of making staff lose morale. The budgeting process is usually sequential and thus takes a long to finish perhaps six to seven months and also consumes management resources. The traditional budgetary process involves a lot of repetition before an approval is made and this lowers staff morale (Drury, 2005, 290).

The traditional budgeting model is also disadvantageous because it is not linked to the strategy. Usually, the act of integrating the organizations’ budgeting and planning process with the balanced scorecard is important as far as organizational strategy is concerned. In many organizations, budgets act as a managerial tool for allocating resources, reviewing performance and establishing goals to be achieved. However, traditional budgets have the limitation in that it does not link the strategy and this implies that the management attention turns out to be riveted with regards to achieving the financial targets. Bob Lutz who was the Chief Executive Officer of Chrysler Corporation once declared that traditional budgets have become a means of repression instead of innovation. The failure of traditional budgets to link with the organizational strategy has become a concern among many corporate heads. For instance, the Borealis Company which is a Danish company once indicated that traditional budgets have become an annual event that hinders the customers’ responsiveness and also which absorbs the organizational resources. The recent years have seen many corporations adopting innovation as a competitive advantage tool. The failure of traditional budgets to be linked with the organizational strategy implies that companies are not able to compete with their rivals in the industry. The failure of traditional budgets to get linked with the organizational objectives also implies that strategic positioning is not given a top priority. The traditional budgeting process thus weakens strategic resolve as line people and staff members tend to focus on the budgeting mechanisms instead of focusing on strategic issues. This also poses a challenge to the organizational leadership team as they are not able to relate the strategic plans with the budgeted expenses (Kaplan, & Norton, 2001, 294).

The traditional budgeting process uses the general ledger mechanism to restrict the managers from huge spending. The general ledger systems play an important role in tracking the spending i.e. it helps in reporting the company’ profit and loss. However, many staff remembers who are involved in the traditional budgeting process usually budgets balance sheet, direct revenues and direct expenses amounts for the specific areas of their duty. Thus the staff members who are involved in the traditional budgeting process tend to ignore the budget profitability. The managers usually assign the back office members to budget their numbers and this is dangerous since the back office members are do not constitute part of the management. The back office once involved in the budgeting process fails to integrate their responsibilities with the planning efforts and thus a disconnect occurs. The back office members once involved in the budgetary process may focus on the incremental costs and thus disregard the costs that were embedded during the last period (Mittal, 2009, 45).

Traditional budgets hinder the decision-making process because it does not provide the decision-makers with well-organized information. The traditional budgeting process usually provides information that is irrelevant and unreliable. On many occasions, the information that is provided by traditional budgets is inaccurate and this hinders decision making by users. Traditional budgeting models are not market oriented and this implies that they don’t provide the users with information about the changes that occur in the market. Furthermore, annual budgeting models consume a lot of time implying that the budgetary process may be rushed to get finished in the stipulated time. This in turn means that there may not be adequate time for analysing the data and thus inaccurate figures may be obtained. Also, traditional budgeting models do not encourage the sharing of information and this has the effect of making staff members feel undervalued (Shah, 2007,162).

Another inherent weakness of the traditional budgeting process is that it encourages gaming behaviours. Usually, the finance managers are concerned with ensuring that the budget is presentable to the board members. This in turn promotes dishonesty and can cause fraud within the organization. Traditional budgeting thus has the effect of undermining the company’s growth as it forces managers to manipulate the financial statements so as to please the board members. The traditional budgeting models can lead to corporate failure as it is characterized by tense negotiations and unending dull meetings. This approach usually encourages the line managers and other staff members who are involved in the budgetary process to set low targets so as to inflate the results (Fahy, et al., 2005, 114).

How the traditional budgeting process hinders the effective implementation of alternative models

The alternative methods also known as the newer approaches are meant to overcome the inherent weaknesses that are associated with the traditional budgeting model. The traditional budgeting process usually acts as a barrier to effective implementation of alternative models i.e. benchmarking, balanced scorecard and activity-based models. The fooling discusses how the traditional budgeting process hinders the effective implementation of each of the above alternative models.

Traditional budgeting process and benchmarking

Benchmarks provide the organization with mechanisms for measuring the activities. The organization can set benchmarks against its competitors. Traditional budgeting acts as a barrier to benchmarking due to the fact it uses the internal annual targets which are short-term oriented instead of using the external benchmarking methods which are future-oriented. The internal annual targets usually do not help in controlling costs. The bargaining process is often experienced when the budget is being established and so, the internal annual targets usually do not help in avoiding the process (Hope & Fraser, 2004, 104).

The Balanced scorecard

This scorecard is used to assess the performance of the organization by use of parameters such as customer, internal business process et cetera. The balancing scorecard takes into consideration the outcomes in finance and other departments like the marketing, operational among others. This is beneficial to the organization since it is capable of taking a 360 degrees view of the business (Verweire & Berghe, 2004, 47).

It is important to integrate the balanced scorecard with a company’s budgeting and planning process so as to create an organization that is strategically focused. Strategy is very important as far as organizational success is concerned. A balanced scorecard acts as a tool for managing the strategy in organizations. However, a balanced scorecard requires to be integrated with the traditional budget for success to be achieved. This has been a challenge due to the differences that exist between the cultures and disciplines of strategic budgeting and planning. A disconnect between the traditional budgeting model and the strategy occurs since most organizations fail to integrate their budgets into their strategy. Balanced scorecards are depended on the industry and therefore, a single balanced scorecard cannot be used to measure the performance of all organizations (Kaplan, & Norton, 2006, 280).

The traditional budgeting process act as a barrier to the effective implementation of the balanced scorecard model and this, in turn, hinders information gathering. Balanced scorecards are useful in the decision making process by providing the users with guidelines on how to collect and summarize data for a healthy budget. Most organizations usually pervert the balanced scorecard and use them as an employees’ monitoring tool instead of using them to measure the organizational performance. Also, forming a scorecard that is viable is burdensome as the process requires many variables. Implementing scorecards involves some activities. These include breaking down the vision of the business into operational goals, making the vision clear to the people involved, integrating the vision into other things like individual performance, business planning among others (Rasmussen, 2003, 136).

Traditional budgeting process and activity-based models

Activity based budgeting commonly known as ABB is a budgeting model that identifies the cost drivers in the activities and this allows the financial managers to develop accurate forecasts as opposed to using the traditional budgeting model. By using activity based budgeting; one can easily allocate costs effectively. Although many firms are aware of the inherent weaknesses, of the traditional budgeting model, little effort has been taken to amend these weaknesses. The Activity-based model thus provides hopes of mending the matters. Activity based budgeting focuses on the success drivers within an organization. The success of activity-based budgeting depends on the effectiveness of its implementation. On the ABB is implemented, it enables the managers to clearly understand the company’s costs.ABB if implemented enables the organization to increase control with regards to its expenses. Activity-based budgeting enhances the understanding of organizational activities. However, the traditional budgeting model act as a barrier to effective implementation of activity-based budgeting by; ignoring the results and thus making it hard to determine the allocation methods. Also, the activity based model is very hard to implement and therefore, it calls for the use of an activity-based system. The traditional budgeting process also hinders the effective implementation of activity-based budgeting in that it requires the employees to record details on how they spend their time and this is challenging since it’s cumbersome. The ability of the workers to track all their time is the idea behind the effectiveness of this model and this implies that the organization must be familiar with ‘garbage in’ and ‘garbage out’ (Bragg, 2010, 112).

Conclusion

The traditional budgeting process has inherent weaknesses and therefore managers require seeking alternatives to annual budgeting i.e. better budgeting. The traditional budgeting model is disadvantageous because it is costly and also consumes a lot of time. Traditional budgeting is also not linked to the strategy. Traditional budgets hinder the decision-making process because it does not provide the decision-makers with well-organized information. The traditional budgeting process uses involves the back office members in the budget making process and they tend to ignore the budget profitability. Also, the traditional budgeting process encourages gaming behaviors and this may result in organizational failure. Better budgeting is aimed at diminishing the inherent weaknesses of the traditional budgeting model by establishing an effective budgeting method. The alternatives to the annual budgeting model include benchmarking, balanced scorecard and activity based models. However, it traditional budgeting model act as a barrier to the effective implementation of better budgeting models.

Reference List

Bragg, S.M., 2010. Accounting Best Practices. Hobiken: John Wiley and Sons.

Drury, C., 2005. Management accounting for business. Stamford: Cengage Learning.

Fahy, M. et al., 2005. Beyond governance: creating corporate value through Performance, conformance and responsibility. Hoboken: John Wiley and Sons.

Hope, F & Fraser, R., 2004. Beyond budgeting: how managers can break free From the annual performance trap. Boston: Harvard Business Press.

Kaplan, R.S. & Noerton, D.P., 2001.The strategy-focused organization: how Balanced scorecard companies thrive in the new business environment. Boston: Harvard Business Press.

Kaplan, R.S. & Norton, D.P., 2006. Alignment: using the balanced scorecard to Create corporate synergies. Boston: Harvard Business Press.

Mittal, R.R., 2009. SPEND MANAGEMENT: Increasing Value, Performance and Efficiency. New Delhi: Global India Publications.

Rasmussen, N., 2003. Process improvement for effective budgeting and financial Reporting. Hoboken: John Wiley and Sons.

Scarlett, R., 2006. CIMA Learning System 2007 Performance Evaluation. London: Butterworth-Heinemann.

Shah, A., 2007. Participatory budgeting. Washington D.C: World Bank Publications.

Verweire, K. & Berghe, L.2004.Integrated performance management: a guide to strategy implementation. Thousand Oaks: SAGE.

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