The Purposes of Budgeting - Essay Example

? Accounting Table of Contents The Purposes of Budgeting 2 Conventional Budgeting Process in the Global Context 2 Zero-based Budgeting 3 Activity-based Budgeting 4 Beyond Budgeting Model 4 The Behavioural Aspects of Budgeting 6 Reflection 7 Bibliography 8 Traditionally, the main use of budgeting has been to control expenses and facilitate planning process. Resources are scarce and the budgeting is used as a tool to deploy available resources judiciously for improving the organisational performance. The Purposes of Budgeting Budgeting helps in several ways: it helps control expenses and works as a tool to monitor planning processes; it also helps forecast future revenues for businesses; it documents and serves the purpose of a guide giving future directions to the businesses. With the help of budget, the management conveys its aspirations across different divisions of the organisation and it also serves as a vehicle to resolve conflicts between the groups within the organization. Thus, budgeting is helpful to the organisation in myriads of ways. Conventional Budgeting Process in the Global Context Conventional budgeting process employs the incremental approach. The incremental approach, while preparing this year’s budget, essentially takes into account last year’s budgetary numbers and depending upon the aspirations of the management, all numbers on different heads such as revenue, labour charges, utility expenses, overheads are revised suitably. For example, twenty percent increase in revenue generation will provide corresponding rise in raw material consumption, utilities and other necessary charges. If the increase in revenue does not warrant any increase in manpower then there would be no increase in the manpower expense except the salary revision granted to the existing staff. It would be worthwhile to elaborate some of the drawbacks with traditional budgeting in the larger context. The incremental approach in the traditional budgeting process misses out several things that include careful evaluation and audit of the several wasteful processes that warrant improvement in order to increase efficiency in the business. For example, it fails to encourage a scrutiny on improving productivity levels through changed processes or employing means that lead to reducing wastages in the production processes. The production department is considered a cost center in the organization. In the traditional budget approach, the management straight away grants funds for all necessary expenses based on last year's budget and production department continues to follow the same old routine; however, in this process, innovative ideas do not get enough support and motivation that is highly required for an organization operating globally for satisfying changing needs of the customers. The same is equally applicable to other departments of the organisation. The traditional budgeting approach was fine during pre-marketing era when competition was not intense and consumers were not demanding (Better Budgeting (2004). Zero-based Budgeting Zero-based budgeting is a step forward refining conventional budgeting process where things do not start from the previous year's budgeting level. In fact, it all starts afresh and the managers need to justify every single activity to run their departments. The manager carefully studies departmental activities and breaks them into several decision packages. Each decision package is then studied intensely to arrive at its budgetary needs systematically. Each decision package is described with details and its related costs. Carefully choosing each package with its likely impact on the objectives to be achieved automatically justifies whether expense is necessary on the chosen activity or not. Accordingly, some activities are chosen and some are discarded. The budgetary allocations on chosen activities help make a realistic budget for a given department and thus, for entire organization. This is certainly a better approach from the traditional budgeting process because it removes several drawbacks associated with it. As there are some benefits with zero-based budgeting, there are some drawbacks too. The biggest drawback is that it consumes significant amount of manager's time. Moreover, there are more chances of inter-department conflicts in such budgeting system. Short-term benefits may sidetrack long-term goals (ICBGlobal, 2012). Activity-based Budgeting Activity based budgeting takes into consideration the costs of all activities that are accomplished and how they relate to each other to complete a task in an organisation. It has again some limitations. For example, all support services are not considered a part of products or services delivered to the customers and they may not be given due importance. Thus, this approach tends to segregate each activity into two kinds – the important and less important function. This is not an appropriate approach, especially in the global context to satisfy all stakeholders of an organization that include customers, suppliers, investors, employees and society (Shane, 2005). Beyond Budgeting Model Budgeting is also known as 'command and control' management. ‘Beyond budgeting’ thus, means relinquishing all kinds of command and control within the organisation setting employees free for innovation, strategic formulation and implementation with an ultimate objective to satisfy customers and outpace rivals. In today's global businesses, strategies are extremely necessary to thwart the competition and budgeting tries to stifle strategic initiatives. Innovation is a basic necessity for the survival of any businesses globally or otherwise and budgeting simply goes against innovative thinking and ideas. Today's businesses need to follow and encourage ethical behaviour in its dealing with all stakeholders and budgeting just encourages opposite to that. Budgeting brings strong stereotype behaviour in its wake and that is highly undesirable in the dynamic global businesses (Hope and Fraser, 2003). 'Beyond budgeting' is a newer kind of approach that relieves staff from the control and command systems and allowing them to share, learn and improve the processes freely. The following examples of the companies found to be highly successful in their field of operations will help understand what precisely ‘beyond budgeting model’ wants to achieve. In Toyota, the management's sole focus is on improving the production processes to meet external and internal customer's needs. As such, neither there are any fixed targets nor any annual budgetary contracts formulated. All resources move just-in-time basis to execute customer’s order. And even then it is not a mean achievement that the company is the most lean and thin with the most efficient production lines (Beyond Budgeting, 2013). Handelsbanken is in the financial services business with the highest customer satisfaction ratings in the UK and Sweden. It is one of the most cost efficient banks (with a cost-to-income ratio of around 40 percent) in the world. Post 2008 financial crisis, its profits even increased when other banks were down with either losses or huge fall in the profits. Branches are granted with necessary decision-making power. All goals are set locally without any need to inform higher authority. No targets are thrust on branches from higher ups. All information is shared among staff and motivation comes through peer comparisons. All branches know their performance through some simple parameters such as return-on-equity, cost over income ratio and profit per employee at branch level. No budgetary exercise is done in traditional sense of the word. The approach is successful in the sense that it helps reduce costs substantially ((Beyond Budgeting, 2013). Southwest Airlines in the US is an organisation that is the most cost efficient among similar service organisations. The focus is on constant improvement in performance in terms of meeting customer needs. Cost per seat mile is the benchmark criteria to measure the cost performance. The employees are set free from any fixed contract to allow free flow of innovative thinking to emerge. The company has been able to make profit even during tough economic recessionary period of recent years ((Beyond Budgeting, 2013). Some of the other corporations in the UK following ‘beyond budgeting philosophy’ are ‘Leyland Trucks’ and ‘John Lewis Partnership’. In fact, currently, organizations in the fields as diverse as IT services, oil & gas, telecommunications and numerous others have been found adopting beyond budgeting model in their global operations with high success rate (Better Budgeting, 2004). The Behavioural Aspects of Budgeting The budget, in general, serves the purpose of measuring managerial performance. It is usually used as a command and control system to manage the activities. In a global business, when it is used as a tool to measure the managerial performance in terms of rewards or punishment then in all likelihood, the correct information will not reach to higher management. Distorted information never does any good to the organisation. When the management inflicts any punishment to the employee, it is seen as authoritarianism in the organization. Punishment and punitive actions create resentment among employees and they become less enthusiastic in delivering something outstanding. That is also a reason behind overestimating cost and underestimating revenue in any budgetary exercise. Similarly, management does have a tendency to cut on budgetary expenses and inflate revenue estimates so that they can outmaneuver employees' budgetary padding. The budgetary exercise, thus, creates a tug-of-war between management and staff not serving any useful purpose (Lucey, 2003). Budgeting may cause several other behavioural problems and that can be listed as per the following (Lucey, 2003). 1. If for some reasons, the budgetary targets are set lenient then the true potential of the employee will not get exposed. 2. While strictly following the budgetary numbers, the employee of one department may act against the other department harming the organization as a whole. 3. Resentment or dissatisfaction may crop in when an employee feels that the budgetary numbers are much difficult to achieve. 4. While working within the given budget, employee’s own initiative may take a backseat. 5. Budgeting tends to omit non-financial goals of the organisation. Reflection In the world of globalisation, companies operate in a highly competitive environment to satisfy customers’ needs. Global businesses need to exhibit enough resilience and dynamism while operating at the different parts of the world. ‘Beyond budgeting’ model is found to be more appropriate with rational approach to meet several strategic objectives. More and more large and medium businesses globally in the manufacturing and the service sectors have been increasingly adopting ‘beyond budgeting’ model in their day-to-day operations with success and this approach is certainly going to survive in the years to come. Bibliography Better Budgeting (2004). The Chartered Institute of Management Accountants. [Online] Available from http://www.cimaglobal.com/Documents/ImportedDocuments/betterbudgeting_joint.pdf [Accessed 9 April 2013] Beyond Budgeting (2013). BBRT - Beyond Budgeting Roundtable. [Online] Available from http://www.bbrt.org/beyond-budgeting/bb-bbo.html [Accessed 9 April 2013] Hope, J. and Fraser, R. (2003). Who Needs Budgets? Harvard Business Review. [Online] Available from http://hbr.org/2003/02/who-needs-budgets/ar/1 [Accessed 9 April 2013] ICBGlobal (2012). The Institute of Certified Bookkeepers. [Online] Available from http://downloads.icbglobal.org/uk/articles/zero-based_budgeting.pdf [Accessed 9 April 2013] Lucey, T. (2003). Management Accounting. 5th ed., Cengage Learning. London. Shane, J.M. (2005). Activity-Based Budgeting: Creating a Nexus between Workload and Costs. [Online] Available from http://www.jonmshane.com/ABB1.pdf [Accessed 9 April 2013] Read More