This report will discuss the advantages and disadvantages of budgeting. It will demonstrate the effects of applied budgeting in today’s enterprises. Alternatives to the traditional budgeting process will be given; consisting of “Better Budgeting” as an improvement of the system and “Beyond Budgeting” as a way of abolishing the whole process.
Table of Contents
1. Introduction
2. Evaluation of budgeting – a pro and con
2.1. Advantages
Planning
Framework of Control
Coordination and Communication
Performance Evaluation and Learning
Motivation
2.2. Disadvantages
Out of Date
Flexibility / Adaptability
Strategic Gap
Short Term Focus
Top Down
Relevance
Efficiency
Complexity
Management Behaviour
3. Alternatives to traditional budgeting
3.1 Better Budgeting
Activity Based Budgeting (ABB)
Zero Based Budgeting (ZBB)
Rolling Budgets and Forecasts
3.2. Value Based Management
3.3. Balanced Scorecard (BSC)
3.4. Beyond Budgeting
4. A possible solution
References
Appendices
Appendix 1: the 4 M´s of the EVA
Appendix 2: the perspectives of the BSC
Appendix 3: Beyond budgeting
1. Introduction
In the last years the discussion about budgeting has become livelier. Supporters of the traditional budgeting process consider it as crucial for the success of an enterprise. On the other hand, the opponents of budgeting regard the process as unnecessary and obstructive in matters of economic efficiency and therefore success.
Over the years, the community of adversaries of budgeting has grown. Hence, new ideas were created and alternatives were brought to life. Meanwhile, the defenders of the budgeting process realized the necessity of reforming the system.
As a result, the discussion about budgeting was shaped to be a question of “life or death.” The opponents propose eliminating the whole process. As an alternative, Dr. Peter Bruns, head of the Beyond Budgeting Round Table (BBRT), suggest a new management philosophy: going “Beyond Budgeting”. At the same time, proponents still believe in budgeting and “just” recommend optimizing the process.
This report will discuss the advantages and disadvantages of budgeting. It will demonstrate the effects of applied budgeting in today’s enterprises. Alternatives to the traditional budgeting process will be given; consisting of “Better Budgeting” as an improvement of the system and “Beyond Budgeting” as a way of abolishing the whole process.
2. Evaluation of budgeting – a pro and con
2.1. Advantages
Although most Managers are aware of the problems budgeting can cause, many still consider it a helpful accompanying process and for the course of action indispensable [CIMA, 2004]. Budgeting presumably is used for various objectives. As long as fulfilled, these purposes are the advantages of budgeting.
Planning
Budgeting as a tool for planning allows organizations to prepare for the future and arrange necessary resources. Strategic Plans are usually decided on through another technique, trying to match a vision with the capabilities on the long term decision process [Drury, 2001]. However, the budget allows a detailed plan for the resources and therefore improves its allocation [Colman, 2005].
Wells (2004) argues that having planned ahead, a budget aids to adjust personnel, allocate human and physical resources, organizes the acquisition of equipment, grants purchasing on time, etc.
Budgeting compels managers to think about the future [Carter et al., 1997]. Problems and opportunities can be anticipated. Managers are encouraged to find a solution for upcoming environmental changes and minimize the negative impact of hasty decisions [Drury, 2001]. This enables the organization to operate proactive instead of reactive [Wells, 2004].
Looking at budgeting as a planning tool, you see that it gives an organization a detailed plan for achieving targets, and therefore as well purpose and direction [Carter et al., 1997]. This map, says Kathryn Jehle in “Strategic Finance,” can guide a company to competitive advantage.
Framework of Control
Colman (2005) suggest that organizations should provide “a road map explaining where the company is, where it wants to go and how it will get there”, as discussed above. Through this planning, it as well enables enterprises to establish a framework of control. Almost every industry has been using budgeting as a controlling instrument. As an example, Kimberly Collins of CMO (2005) finds that the transparency of the company’s procedures facilitates a better understanding of costs and therefore helps marketers to make appropriate decisions.
As Drury (2001) states, a crucial factor of budgetary control is the variance analysis. Since the resources are allocated in advance and the company follows a “road map”, deviation of sales or costs etc. can be investigated. The Tulip Tree Press (2005) comments that with this knowledge of what is going on and why it happens managers can better react to occurring problems, or even to arising opportunities.
According to Howard (2005), the controlling and anticipating part of budgeting helps to identify and eliminate avoidable costs. As a caste study of Kraft Foods (2005) shows, budgetary control contributes to focusing on value adding activities which create shareholder value.
According to the 2004 published CIMA/ICAEW report on Better Budgeting Forum, budgeting” provides an overall framework of control without which it would be impossible to manage.
Coordination and Communication
Budgeting is as well an approach to solve one of the major challenges of a large company: coordination and communication. As Colman (2001) argues, budgeting aids coordination and facilitates control. The various departments of an organization aim for different goals. Some of these goals may be antithetical. For example goals the purchasing manager and the production mangers aim for. On the one hand, the purchasing manager wants to place larger orders to receive discounts. On the other hand, the production manager wants to keep stocks low because of the costs. Budgeting compels the managers to communicate and find the best solution [cf. Drury, 2001 p.284].
Marginson et al. argue that budgeting encourage managers to communicate. This is not only with their manager colleagues, but also with the colleagues within the department to state the targets and the tactics.
Furthermore, the budgeting process compels the higher management to define areas of responsibilities [Carter at al., 1997]. This way evaluation can be more effective and the cause and effect of action can be investigated (see Performance Evaluation and Learning). As well, a motivating effect can be seen when employees are given responsibility (see Motivation).
Performance Evaluation and Learning
Budgets give a chance to evaluate performance. First of all, the performance of the company can be looked at. By comparing the budget and the actual sales, costs, etc. you can see how well the targets are being achieved. This variance analysis helps managers to find out to what they should pay attention and focus further actions. As soon as a company “goes off track”, the required actions to fix the problem can be applied.
The second point is that the achievement of targets in the budget can be a lead for management appraisal. The manager himself can evaluate his own accomplishments or otherwise [Rieg, 2005]. And the higher levels of management have a proper basis for personnel decisions.
Furthermore, analysis and evaluation of the procedures create a learning-effect. Accomplishments and failures can be investigated and explained. Hence, the experienced cause and affect of certain actions can be considered before taking action.
Motivation
The motivation of managers as well as employees is crucial for the economic success of an enterprise. Setting targets that are achievable is a major factor in motivating people into putting effort into their actions. Having a road map simplifies the every day business in a more and more complex economy. And giving people a challenge makes them feel more confident. Confidence is an important step in Maslow’s hierarchy of needs [WIKIPEDIA, 2005].
The budgeting process involves many employees, even in the lower levels, in the planning and the evaluation. Howard (2004) argues that this factor as well motivates employees. Involvement usually causes identification and association with the employer.
2.2. Disadvantages
As already mentioned, budgeting does not only have admirers. Even high ranking CEO’s complain about the system. Jack Welch, CEO of General Electric, said that “budget[s are] the bane of corporate America. It never should have existed.” The disapproval for budgeting comes from various reasons. Evidence suggests that there are several disadvantages regarding the budgeting processes applied in business´ structures.
Out of Date
One of the biggest criticisms of budgeting is that it is not realistic.
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- Quote paper
- Hassan Moeini (Author), 2005, Beyond Budgeting, Munich, GRIN Verlag, https://www.grin.com/document/73016
