Finance Budgeting Example for Free

Budgeting, if not used effectively, can result in underperformance, corruption and even the failure of the organisation. Budgeting has been used as a method of coordination and control but when left unregulated it can result in the very worst kind of opportunistic behaviour. As a result there have been a number of developments in budgeting, such as the rolling budget and benchmarking performance. It is dependent on the organisation which method of budgeting is optimal. Traditionally budgeting has been used by organisations as an accounting tool to plan and control the activities within an organisation or rather ‘The quantitative expression of a plan of action and an aid to the coordination and implementation of the plan’ (Bhimani et al, 2008, p935). In relation to planning managers are expected to forecast ‘sales, profit, and capital expenditure’ (Hope and Fraser 2003). This information is then analysed by executive managers and the forecasts of all the different departments within the organisation are coordinated and adapted to create a final budget. These budgets are usually set for a short period of time, usually a year, and are set months before the time the budget start date. It is therefore a good way for managers to communicate as these budgets would supposedly identify any potential problems within the departments and plan to action them in the next budget.

For example potential bottle necking whereby a department uses more resources than it produces. It also allows each department to understand where it lies in the coordination of the organisation. When a budgeted target is fixed management is evaluated in relation to whether or not they have met the target which provides a measure of control. Managers are directly responsible for the performance of the activities they coordinate and monitor. If managers meet the target they will be rewarded, however if they fail it will reflect badly on their performance, this system provides motivation. It also allows for authorised expenditure so departments do not have to seek permission for purchasing which saves time. Each year the budget can be reviewed and modified in order to better suit the actual performances and to allocate resources more effectively. On the surface the idea of traditional budgets seems an effective way to coordinate and monitor an organisation, in reality it can lead to underperformance, corruption and even failure of the organisation. Managers are set a target with the incentive of a bonus so if the target is reached their priority will be to meet the target. As the target has a deadline they will aim to meet the goal irrespective of the long term affect on the organisation. Targeting can lead to a reduction in quality of goods and services.

For example if a furniture store set their sales team a target and they could sell to customers on credit they may sell furniture to customers who may be unable to pay back the credit. But the short term results are what matters in terms of bonuses not the long term credibility of the customers. If managers are unable to meet the short term target managers may manipulate results in order to receive a higher bonus in the next period rather that not receive the bonus two periods in a row (Big Bath Theory, Jensen, 2003, p387). As a result it will be difficult for an organisation to have the information required to set an accurate budget in future as a result the communication benefits are reduced.

Managers may also manipulate information in order that the target will be set lower than they are capable of achieving and so there is no pressure to work at maximum capacity (Slack Budget). Budgeting therefore promotes manipulation of information by creative accounting, and a reduction in the quality of performance of departments. Traditional budgeting is very inflexible and in times of turbulence of an economy or market it is not easily adapted. Targets are set sometimes months before a time period begins and then fixed for the entire period. As there is no way to predict the changes in the state of the economy or particular changes of circumstances within a market traditional budgets do not allow for these changes. Traditional budgets are also very time consuming ‘absorbing up to 30% of management time’ (Hope and Fraser 2003) this man power has a cost as every time a fixed budget has to be revised resources are allocated away from other activities. It is also time consuming to negotiate and coordinate a new budget with all the departments in the organisation and by the time a revised budget is agreed it could be too late for it to be effective. Budgets were intended as a way for executives to stay close to customer information and adapt accordingly. However this time consuming nature results in any change being made redundant and the manipulation of information, leading to false information, would result in the wrong changes being implemented. As budgets are fixed it prevents innovation as for innovation to be undertaken in traditional budgeting an organisation will need to be worked into the budget before hand so innovation is stifled.

The obsession with the detail makes it difficult for an organisation to adapt when necessary to the changing circumstances within the environment they operate. In the cases of the budgets over estimating authorised expenditure managers will use every penny they have been allocated so as to keep the same expenditure in the next budget. In contrast Kaizen budgeting could be incorporated whereby the budget ‘explicitly incorporates continuous improvement during the budget period into the resultant budget numbers.’ (Bhimani et al 2008) As a result the role of traditional budgeting must be abolished and a more modern type of budgeting should be adopted. One of these ideas is the idea of a rolling budget whereby a budget is produced every three months and covers a set period of time ‘typically between 5-8 quarters’ (p112 Hope and Fraser 2003). These types of budget eliminate the problem of a fixed dead line so in manipulating performance statistics, so as to reach the target at the end of the year, managers would instead have an incentive to continue performance continuously. Each year two further budgets could be provided to managers one showing the four year plan and one a ten year plan, for example (p112 Hope and Fraser 2003). This would promote long term planning as opposed to short term manipulation of performance. This type of budget is a lot quicker to put together due to its nature and will also be capable of adapting to environmental turbulences relatively quickly. Kaplan and Norton (1992) created the Balance Scorecard as a measure of performance where it ‘not only concentrate on financial dimensions of performance but also take into account non-financial ones. This is achieved through incorporation of ‘customer’, ‘Leaning and growth’, and ‘internal efficiency’ perspectives.’ (Cieslak and Kalling 2007 p3). Benchmarking is another option where key performance indicators (KPI) are used to compare the work of an individual, or section of the organisations.

These benchmarks can be set against peers within the same organisation or peers of a competitor organisation. In this case the comparison is relative rather than set and so the focus is shifted from short term goals of the firm to long term improvement and performance of individuals and their department (Drew 1997). The benchmarks are set on process, product/services and strategy (Drew 1997). The information required to improve efficiency lies with the employees and so innovation is able to emerge as more responsibility is given to the workers. Communication is restored and the time taken on setting out a budget is reduced as the aim is not to achieve a target but to get the best result. Jensen (2003) would argue that the source of the loss of integrity is the managerial hierarchy and so decentralisation could be a solution. This decentralisation can be achieved by giving more power to the workers in the form of participating in budget setting (Hofstede 1968 the game of budgetary control p175). This can act as a source of motivation as the workers will feel empowered rather than suppresses by the target setting focus on figures rather than quality. This can also act as a source of learning for both ends of the hierarchy.

Stewart (1990) argued that the decentralisation of debt equity was another way to motivate the workers. While there is a very negative perception of the traditional role Marginson and Ogden (2004) for the benefits of traditional marketing. ‘Managers welcomed the certainty created by the combination of clear goals and well-specified objectives and a performance evaluation system that was tightly focused on how successfully those objectives have been achieved’ (Marginson and Ogden 2004 p436). It is also worth considering the cost of implementing such changed, as organisations will have to retrain their workers and reorganise the system (Jensen, 2003, p403). As a result organisations must assess the costs and benefits to their specific organisation before abandoning traditional budgeting entirely. Traditional budgeting in small firms could still be effective. In conclusion the full benefit of abolishing traditional budgeting is dependent entirely on how effectively an organisation implements new developments. While developments such as rolling budgets and benchmarking solve some of the problems there is a cost of introducing them. Therefore traditional budgeting should not be abolished entirely in all organisations but instead careful consideration should be taken in deciding what should be implemented and how this should be done.

References

• Bhimani, A, C. T. Horngren, S. M. Datar and G. Foster, 2008. Management and Cost Accounting. Essex. Pearson Education Limited.
• Hope, J. And R. Fraser. 2003. Who needs Budgets? Harvard Business Review. 81(2). pp. 108-115.
• Jensen, M. C., 2003. Paying People to Lie: the Truth about Budgeting Process. European Financial Management. 9(3). pp. 379-406
• Kaplan, R. S. And D. P. Norton. 1992. The Balanced Scorecard-Measures That Drive Performance. Harvard Business Review. 70(1). pp. 71-79.
• Cieslak, K. and T. Kalling. 2007. Reasons behind contemporary use of budgets.NNF conference, 9-11 August 2007, Bergen. Lund University, Sweden: pp1-6.
• Drew, S. A. W. 1997. From Knowledge to Action:Impact of Benchmarking on the Organizational Performance. Long Range Planning. 30(3). pp. 427-441. Great Britain. Elsevier Science Ltd.
• Hofstede, G. H. 2001. The Game of Budgetary Control. London. Routledge.
• Stewart, G. B. 1990. Remaking the Public Corporation from Within. Harvard Business Review. 68(4). pp. 126-137.
• Marginson, D. and S. Ogden. 2005. Coping with ambiguity through the budget: the positive effects of budgetary targets on managers’ budgeting behaviour. Accounting, Organizations and Society. 30. pp. 435-456.

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