Beyond Budgeting Routine Table - Literature review Example

Budgeting Budgeting Introduction The Beyond Budgeting Routine Table (BBRT) asserts that traditional budgeting is notonly rigid and inefficient, but also the borderline evil that contributed to corporate scandals such as Enron and WorldCom. Budgets constitute statements of allocation of resources with the primary aim of achieving the objectives of an organization within a specified period. Business organizations have the responsibility of predetermining how they will acquire and apply various resources. Budgets are the financial plans outlining ways through which business enterprises receive and spend money in a particular financial period. Budgets concentrate on predicting the expenses and determining the link between financial resources and human behaviour in order to accomplish policy objectives. The roles of budgeting include coordination, planning the use of resources, forecasting, controlling and motivation; however, traditional budgeting has been criticised because it cannot adapt to the modern dynamic and quickly changing market requirements. Traditional Roles of Budgets Coordination The process of budgeting requires the development of visible budgets for covering each activity, department and function in the organisation (Bartrum, 2006). Achievement of coordination is depends on the extent to which the efforts of organisational departments are related. Organisations strive to achieve coordination for effective decision-making endeavours. Thus, one of the roles of budgeting in organisations is to achieve coordination across functions and departments in order to enhance efficiency and effectiveness in production. Planning for resource utilisation Budgeting paves way for long-term plans and their implementation. The process of planning involves determination of objectives to be attained at a future predetermined time (Bartrum, 2006). This implies that companies make plans before they open a particular financial period and dedicate their energies and resources towards the achievement of such objectives. Companies transform plans into budgets when they attach monetary values to plans. Libby and Murray-Lindsay (2010) posit that good planning without effective control is wasting time. The objectives can only be achieved when plans are laid down in advance in order to guide internal stakeholders on the right direction for proper business management. Forecasting Forecasting is the process of making statements for future outcomes. Budgeting constitutes a forecasting process used for estimating costs that will be incurred during the specified future date (Wiseman, 2010). Risk and uncertainty are central to forecasting and prediction because it is necessary to indicate the degree of uncertainty attached to forecasts. Budgets forecast future expenses and sets standards for best performance. Controlling Controlling involves comparing actual results with the budgeted results and reporting upon the variances. Budgeting is used to set out standards of performance for the organisation (Association of Accounting Technicians, 2011). When the financial period ends, the management compares the standards with actual results in order to determine variance from the standards. Budgets, therefore, set a control gauge that assists in accomplishing the plans set within agreed expenditure limits. The process of controlling involves preparation of budgets based on the predetermined data on performance and prices, measurement of actual performance, comparing the budget with actual performance to determine the variance, ascertaining reasons for variances, and taking corrective actions through administration of proper strategies and measures. A tool for motivation Companies view budgets as bargaining processes in which managers compete with each other for proper use of scarce resources. The process of budgeting involves setting budgets, which have to be achieved. Companies that set tight budgets motivate organisational members as they strive to achieve them (Dugdale & Lyne, 2006). Involvement of managers in the budget preparation process motivates them towards achieving the goals they have participated in setting. Companies, however, should not impose budgets on managers because they may discourage them if they perceive them as unattainable. A Method of Communication The full budgeting process involves liaison and discussion among all levels of the management. Managers from low, middle and top levels of the organisation contribute towards the budgeting process. Both vertical and horizontal communication is necessary for ensuring proper coordination of activities. Vertical communication involves transmission of information between the upper and lower levels of management; this may involve communication between top managers and middle level managers and low-level managers and operational employees. The budget document itself may act as a tool for communication of the expectations of the departments and managers (Hope & Fraser, 2003). The budget informs all organisational members about their roles, procedures and expenses for each production process. High standards set call for hard work and additional input in terms of labour, time and other financial resource. Criticisms of Traditional Budgeting Traditional budgeting encourages rigid planning that limits flexibility. Rigidity is not appropriate in modern business environments characterised by dynamism and complexity. Business environment changes across time and place. The dynamism nature of business requires flexibility in order to suit various environments and circumstances. This element makes traditional budgeting inapplicable because businesses prepare budgets without space for alterations. Regional laws and regulations, cutthroat competition, and promotional drawbacks that characterise most countries cause the complex nature of business environments. According to Ekholm and Wallin (2000), budgets that do not provide for alterations are not appropriate for business control especially for cross-border investments. Preparing traditional budgets is a time-consuming and costly exercise. Wiseman (2010) asserts that the time required for making traditional budgets ranges between two and three months. Developing a budget involves several repetitive steps before the final budget approval. For example, participative budgeting involves managers across all levels of the organisation, and sometimes all employees, developing their own initial estimates for costs. Langfield-Smith, Thorne and Hilton (2006) argue that participative budgeting requires widespread negotiations between managers at different levels until an acceptable budget is approved. According to Bartrum (2006), the most efficient companies can take up to seventy-nine days to plan their budgets; the worst corporations take approximately two hundred and ten days before their budgets are approved. According to the estimates of Ford Motor Company, the company spends $1.2 billion every year for making budgets. These financial expenditures are consumed because traditional budgeting in the company involves several personnel and requires the input of more than 30 percent of the strategic managers and financial managers. Traditional budgeting encourages managers and employees to meet the lowest targets instead of concentrating on beating the target set. Lack of focus on meeting the target set is inconsistent with the principles of total quality management (Hope & Fraser, 2003). Total quality management requires companies to produce products focusing on meeting customer satisfaction. The primary objective of traditional budgeting is to meet the company’s minimum targets. Concentrating on numerical targets is one of the elements that Edward Deming was opposed to in his 14-point quality program. Deming argued that price has no meaning without proper measure of the quality of materials, tools, and machines being purchased. Traditional budgeting do not provide for use of statistical tools that can be used to judge the quality of vendors and the purchased raw materials or parts. Concentration on numerical targets is also inconsistent with Six Sigma quality tools of quality management. Therefore, traditional budgeting is criticised because it encourages managers and employees to achieve the target results even if the results constitute undesirable actions. Traditional budgets add little or no value to shareholders’ value. Most business enterprises recognise the value of effective management of intellectual assets as the main source of future cash flows. However, traditional budgets do not account for intellectual assets (Wiseman, 2010). Finance managers concentrate on accounting for goodwill alone, which constitutes only 10% of the company’s intellectual property. Shareholders’ value can be improved primarily by proper brand development, growing business relationships, and Research & Development projects meant to identify the best ways of improving the value of the organisation. Traditional budgeting focuses on too short periods that are not sufficient for planning and steering of the organisation. Thus, traditional budgeting restricts business and organisational development in the long-run and add little or no value to the shareholders’ investments. Critics of traditional budgeting argue that the approach encourages organisational stakeholders to spend according to budgets even if the expenditures are not necessary. This is to guard against the next year’s budgets. Companies fear the repercussions of exceeding their budgets because they may lack the financial resources for running the next budget period. Additionally, traditional budgeting leads to increased barriers between departments in the organization rather than encouraging knowledge sharing and integration. Libby and Murray-Lindsay (2010) view traditional budgeting a mechanism for top-down control be senior management. Most companies’ top management is solely responsible for performing budgeting activities. Lower levels of the organisations are only responsible for implementing budgets without questioning. Departmental heads are usually required to submit their budget estimates, but the strategic management has the discretion of determining budget allocations to each department. Evaluation of the Prescriptions of Beyond Budgeting protagonists The primary characteristic of beyond budgeting is rolling budgets that are produced on a quarterly or monthly basis. These budgets exhibit flexibility, avoids overreliance on obsolete figures and result in more timely allocation of resources. The rolling forecasts are founded on balanced scorecard linked to the organisation’s strategy (Libby & Murray-Lindsay, 2010). The balanced scorecard incorporates both financial and non-financial measures of the organisation. Financial measures reveal the actions that have already been taken while non-financial measures constitute drivers for future financial performance. The main advantage of balanced scorecard is that it allows the management to view the business from the perspectives of customers, finance, innovation and learning, and internal business processes. Beyond budgeting incorporates benchmarking that link the targets of managers to external benchmarks as opposed to past performance. Benchmarking is critical in businesses because it helps companies to identify best practices in the industry and adjust their processes in order to ensure competitiveness and sustainability. Proponents of beyond budgeting argue that the approach focuses its efforts on managing future results without dwelling on explaining the past performance (Association of Accounting Technicians, 2011). The past performance does not add any value to businesses; concentrating on future performance is critical for planning and finding improved ways of quality productivity. Beyond budgeting approach allows operational managers to react to the business environment. This is meant to overcome the challenges of rigidity caused by traditional annual budgeting. The modern business arena requires flexibility in order to eliminate inefficiencies that characterise rigid systems. Flexibility is necessary for enhancing profitability because the business can alter the amount of money planned for certain purposes and channel the funds to the more profitable ventures (Dugdale & Lyne, 2006). The approach of beyond budgeting also encourages development of the culture of innovation in organisations. The problem with traditional budgeting is that when budgets are set, changes to adapt to new requirements become impossible. Beyond budgeting provides chances of alterations should new ideas and ways of operations come up. Organisational members, therefore, are encouraged to research and develop innovativeness throughout the financial period. Beyond budgeting shifts the management focus from beating other managers to enhancing the business competitive advantage. This can be achieved through creating a business environment based on competitive success. The approach is suitable for organisations using management approaches that focus on quality productivity such as total quality management, business process re-engineering and continuous improvement. Given that the primary focus of businesses is customer satisfaction, beyond budgeting provides foundations for establishing customer-oriented teams and eliminating behavioural issues by making rewards team-based. Beyond budgeting approach is applicable to both the private and the public sector. In the private sector, the approach focuses on empowering managers to eliminate resource constraints and creating open information systems throughout the organisation (Hope & Fraser, 2003). The public sector enjoys increased flexibility, although public sectors are mostly constrained by the inability to adopt beneficial transitions. Regardless of this, beyond budgeting enables managers to eliminate internal politics that has always limited performance in the public sectors. Conclusion Budgeting is the primary activity of the management in organisations. Regardless of its functions in businesses, traditional budgeting has several limitations. Preparing budgets consume a great deal of time and financial resources due to widespread negotiations that characterise the process before the budget is approved. Traditional budgeting ignores drivers of shareholder value by focusing on short-term financial performance. Traditional budgeting adds value to the organisation, but encourages dysfunctional and wasteful behaviours in organisations. Budgeting experts advocate for the implementation of beyond budgeting approaches that are more flexible, less sophisticated, simplified and guarantee efficiency and effectiveness in the modern business world. Beyond budgeting is a leadership philosophy, which relate to alternative approaches to budgeting that should be used instead of traditional annual budgeting. References Association of Accounting Technicians. (2011). Budgeting. London: BPP Learning Media Ltd. Bartrum, P. (2006). Forecasting the end of budgets. Director, 60(1), pp. 30-33. Dugdale and Lyne, (2006), “Are budgets still needed?” Financial Management, November, pp. 32 – 35 Ekholm,K. and Wallin, J. (2000), “Is the annual budget really dead?” European Accounting Review, 9(4), pp. 519 – 39 Hope, J. and Fraser, R. (2003), “Who needs budgets?” Harvard Business Review, 81 (2), pp. 108 – 115 Hope, J., & Fraser, R. (2003). Beyond budgeting: How managers can break free from the annual performance trap. Boston, Mass: Harvard Business School Press. Langfield-Smith, K., Thorne, H. & Hilton, T. (2006). Management Accounitng. Australia: McGraw-Hill Pty Ltd. Libby, T. and Murray-Lindsay, R. (2010), “Beyond budgeting or budgeting reconsidered? A survey of North American budgeting practice, Management Accounting Research, 23, pp. 56– 75 Wiseman, B. (2010). Budgeting. New York, NY: Weigl Publishers. Read More