Traditional Budgeting and Budgetary Controls Weaknesses

This article outlines the process for budgets within two different industries; one is an extremely stable and static market, and the second is a rapid-changing, constantly changing new and dynamic environment. Budgeting and control of budgets are utilized in a traditional way by the majority of business organizations around the world, despite its many limitations. In a rapidly changing business environment, traditional budgeting should not be the sole method of budgeting that can be employed within a business. There are many alternatives such as Zero-Based Budgeting Beyond-budgeting, Activity-based budgeting, and so on. which can be extremely advantageous and profitable for businesses.

Budget

“A budget is a plan, expressed in financial and/or more general quantitative terms, which extends forward for a period into the future” (Gowthorpe 2003). A typical budget is made by reviewing the past year’s budget as well as actual expenses, including reductions for extra business activities or business activities that are less important and also adjusting in response to changes in the environment like inflation, growth, etc… It’s mostly used to bind managers to specific actions to meet the budget plan. It is typically founded on management hierarchy and centralized oversight.

Benefits of traditional budgeting, as well as budgetary control, are:

  • Budget period income can be compared to expenses of the budget period to figure out whether the operations will yield an income and what amount.
  • Actual results can be compared against budget in order to identify variances in order to determine if corrective action should be made.
  • Budget-based reports aid in the evaluation of the cost of products and services offered and the accomplishments of the business.

The problems associated with budgetary controls include:

  • It is not possible to know what will happen over the next 12 months. Serven (cited in Banham 2000) said, “The customary system of trying to accurately predict what will happen in 12 months and budgeting accordingly is an exercise in futility”.
  • The majority of budgetary processes are expensive and inefficient. It takes many months to complete, and once it’s finished, it is not applicable because of the changes in the business environment.
  • Based on Stewart (2004) Stewart (2004), there are ten main reasons that budget problems can be caused by budget as illustrated below.

While traditional budgeting is not without its shortcomings, the majority of companies continue to rely on it due to its unquestioned place in the top tier of management practices that are accepted (Hope Fraser and Hope, 1999). So, many businesses are now trying for alternatives to traditional budgeting and some are attempting to ditch the practice altogether. But, it’s widely believed by experts that as much as half of the businesses who try to revamp their approach are so exhausted that they stop and return to their traditional methods (Banham 2000).

Traditional Budgeting in Dynamic Business

In a company that is operating in a highly rapid-changing, constantly changing, and highly innovative business environment conventional budgeting is not the best strategy to implement. Budgeting is a hindrance to the company’s success due to the competitive market that demands agility, quick response, and innovation, as well as efficiency improvement, focus on customers as well as shareholder benefit (Daum 2001). It is also the drawback of budgeting as a system to meet these requirements. Businesses that are dynamic must be able to keep pace with changes and adapt to new developments for success.

This is why the Beyond Budgeting approach was introduced. Daum (2001) asserted that “The Beyond Budgeting Model is designed to overcome traditional barriers and to create a flexible, adaptable organization that gives your local managers the self-confidence and freedom to think differently, make decisions rapidly, and collaborate on innovative projects with colleagues in multifunctional teams both within your company and across its borders.” The practice of exercising beyond budgeting could be the solution for many companies suffering from budgeting challenges.

Beyond budgeting refers to the performance management system comprised of a set of interlocking and interdependent processes (Verlag 2005). The goal is to build an adaptive system that adapts to the actual world, which develops the business plan by studying the surrounding environment, i.e. market growth, competitive performance, etc. Instead of trying to meet a bargained amount in the budget the business should strive to surpass this standard of performance (Verlag 2005). This would ensure that managers feel that they are undervalued.

The process of extending budgets is explained in the 12 fundamentals of Beyond Budgeting (BBRT, 2005). The first six “process” principles concern the management of performance that allows employees to react more quickly to the demands of customers and the competitive environment. The sixth and seventh ‘leadership’ principles offer a decentralization system of responsibility for employees in order to allow them to quickly adjust to events that could occur and increase their performance in a relative manner. Beyond budgeting can be done effectively by applying these principles, and businesses can adapt to the ever-changing environment.

12 fundamentals that are Beyond Budgeting

Beyond Budgeting Process Principles

  1. Aspirational Goals Set aspirational objectives that are based on constant improvement and not fixed goals
  2. Rewards Base rewards are based on relative performance and hindsight, not contingent on meeting specific targets.
  3. Planning Plan as a comprehensive and continuous process and not an annual occasion
  4. Resources Create resources that are available upon demand not through budget allocations
  5. Coordination Coordinate cross-company actions in a dynamic manner, not through budgets or plans for the year.
  6. Controls Base checks on KPIs, trends, and relative indicators, not variances with the plans

Beyond Budgeting Leadership Principles

  1. Governance Base governance is based on specific values and boundaries and not on specific budgets and rules
  2. Performance Create a high-performance culture based on relative performance not on achieving goals
  3. Freedom to make decisions Devolve decision-making authority to frontline teams. Don’t manage them micromanage
  4. Accountability Build an organization of small units accountable for the results, not central hierarchy
  5. Customers first. Focus all of your efforts on improving customer service, and not focusing on meeting internal targets
  6. Information Share information and promote openness do not limit it to those who “need” to know

The advantage of extending budgeting beyond the budget is that it can be used to examine goals and strategies, plans for action forecasts, and management reports. It is also possible to compare with competitors and past performance. It will focus on the main factors that drive business performance. The goal is to stay aware and make the most of opportunities that arise and react to threats that could arise by making use of an advanced system of information to make quick decisions. The rapidity of action and effective decision-making are the outcome of overbudgeting. (Hope & Fraser, 1999)

The significant change that is required over budgeting could cause some resistance to changes (Verlag 2005). Organizations will vary in size in terms of culture, size, and business context. It will be difficult to convince important stakeholders that control is still accomplished without budgets (Max & Fraser, 2005). Beyond budgeting can raise questions such as the uncertainty of losing control, giving frontline people the power to make decisions, and relying on them to do what is in the best interests of the company. This is difficult to consider (Hope Fraser and Hope). If these issues are dealt with by the business, it could be a source of longevity.

Examples of firms that have succeeded in going beyond budgeting and have gotten rid of the budgeting method of old include Volvo (one of the most profitable carmakers in Europe), IKEA (the world’s largest furniture retailer and manufacturer), and many more. (Hope & Fraser, 1999). A number of organizations that have gone beyond budgeting discovered that their performance had improved after the budgeting process was discarded in favor of more flexible and adaptable methods of planning, evaluating performance, and management (Stewart 2004).

Activity-Based Budgeting (ABB).

While beyond budgeting is by far the most current method, many companies are not able to adjust to it. Therefore, another option for the business that is dynamic is Activity-Based Budgeting (ABB). Its goal is to create an annual budget from the activities and resources of the business. A financial budget is formulated in conjunction with the creation of an operationally viable budget.

Benefits of the ABB approach.

  • It allows for a better process, product, or activity costing, as well as decision-making, and better allocation of resources to meet the organization’s priorities.
  • It can identify capacity issues and initiate adjustments sooner in the budgeting process in comparison to traditional budgeting that does not keep track of resource consumption patterns.
  • It enhances the ability of managers to adapt to unforeseen circumstances and enhances the measurement of performance, evaluation, and decision-making (Hansen, Otley, et all. 2003).
  • This means that ABB is a great alternative for companies that are constantly evolving because it provides an accurate and precise analysis to rapidly predict the budget’s next installment compared to the traditional method of budgeting.

But, ABB is not without difficulties.

  • As per Barret (2003), ABB is difficult to comprehend regarding the rules that relate outputs and resources to costs and expenses. Therefore, business leaders tend to doubt the methodology.
  • While ABB directly links the increase in the volume of output to increases in specific actions, it doesn’t assist in linking the activities to resources.
  • So any of the applications of any of these options regardless of whether it’s outside budgeting or ABB should be considered in detail, subject to the present situation.

Traditional Budgeting in Static Business

In a business which is in a steady and static market in which there is a slight variation in the quality of products or the demand each year, the traditional approach to budgeting may be the best option (Daum 2001). Static businesses do not have to risk their lives to alter their budget as it will take more money and time than is normal. But if this scenario continued, the business would never expand beyond its current state. This could result in frustration for employees looking for challenges. It is said by Hope & Fraser (1999), “Budgets are well known for reinforcing the command and control culture, constraining freedom and autonomy, and stifling the very challenges that excite prospective managers”.

In order to provide a viable alternative to the static business model, Zero-Based budgeting (ZBB) is proposed. ZBB is a reference to the proposals of Pyhrr (1973); Cheek (1977) and others. to alter the conventional budgeting procedure in organizations in which budgeting is an in-line process in relation to the previous year’s actual expenses. The proposed ZBB process requires every manager to justify their budget request that is based on the assumption that the organization’s duties were commenced with “ground zero”. It requires defining the purpose of an organization’s unit as well as identifying the roles and projects it intends to carry out to meet its goals. The activities are then ranked according to their order in importance (Flamholtz 1983). It is basically a method of distributing scarce resources to areas where they can be most effective.

The benefits of ZBB are cost-saving and improving services, enhancing the discipline required to develop budgets decreasing the entitlement mentality in relation to increases in costs, and helping make the budget discussion more relevant in reviews (LaFaive 2003). However, ZBB could also cause issues such as, for instance, it can make it more time-consuming and costly of budget preparation, and could be too drastic a solution to the problem that is being undertaken, and could cause more problems if it is not implemented in a timely manner. Furthermore, a large commitment needs to be given by all parties concerned in order to make sure that the plan is implemented (LaFaive 2003). ZBB should be considered for static companies to boost efficiency. It is useful in revving up processes that have become stale and ineffective over time (LaFaive 2003).

Variance analysis remains one of the most commonly used tools to measure the discord between the budget plan and actual performance. Based on the study conducted by Sulaiman, Ahmad & Alwi (2005) The standard procedure among the local Japanese (about 71 percent) in addition to local Malaysian firms (about 64 percent) is to examine deviations only when the variance is greater than the specified percentage. This is a common feature of budgeting in the traditional way. However, it’s not suited to be utilized in modern business. So, Ramsey (1999) developed a diagnostic variance analysis, in which budget variances are analyzed using the components based on activity that comprises the variance and analyzed by the overall performance. In the course of this study, the primary reason for the variance is discovered, providing insights into the business to aid in strategic decision-making.

In conclusion, the old-fashioned approach is not a must. Budgeting remains a crucial aspect within the business and requires to be given a lot of attention by the company regardless of the complexity (France 2006). Zero-Based Budgeting and Activity Based Budgeting are only improvements to the traditional methods. In a dynamic-driven company that is constantly evolving environments such as the current business environment, beyond budgeting is a viable alternative, if handled properly in the business. For the static business, ZZB can assist the advancement of the company to help the company grow and be successful in the near future.

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