Effectiveness of Budgetary Control in Unpredictable and Dynamic Environments - Essay Example

Effectiveness of budgetary control in unpredictable and dynamic environments Introduction Formal budgets are prepared by corporations and businesses which are also referred to as a budget process. Formal budget predicts all the revenues, expenditures, and profit that could be generated by the company in the coming year. It has to be approved by the top management. It is very important for any business because corporate planning rely heavily on budgeting. Regardless of its size, it has become an inevitable part for any corporate. It serves as a tool to exercise control over a company’s business operations. Formal budget management needs great skill and care while dealing with company’s finances so that the business doesn’t fall short of finances. Budgeting is a continuous process in large organizations. Operation department create plans to help the company achieve its corporate goals. Overhead costs, capital expenditures, operating expenses and sales are forecasted for the upcoming fiscal year by the unit managers. The forecasted figures are then sent to the upper management for its approval. The upper management reviews all the projected costs, expenditures and revenues and then approves it. Discussion The approved formal budget forms the guideline for operations in the coming year. Monthly and quarterly budget are also prepared by organizations to keep a track of performance against projected figures and takes corrective action if there is any deviation. Upper management has a bottom up approach in respect of budgeting. Corporate managers take the top down approach in meeting business goals. Managers who have a good understanding of profits and sales and have the capacity to overestimate costs typically create successful budgets (Singla, 2009, p. 147). There are various benefits of budgeting such as managers can compare the company’s performance against the projected figures which also forms the basis of their functioning within an organization. They compare the current performance of the company against projected figures and takes corrective action if there is any deviation. In this way, the managers are also able to keep their employees focused and guide them to performance (Lucey, 2003, p. 187). Formal budgeting provides the company with a detailed and comprehensive picture of the immediate future and also informs the company about the possible opportunities and threats. Time is an important factor in the budgeting process. Managers sometimes find themselves completely lost in their effort to meet the rules and regulations that are there in the formal budget. But to have a sound system to exercise control, the first thing that the company should have is a clearly defined process. The process should be able to establish methods and standards by which to measure performance (Forster and Wanna, 2000, p. 86). A formal budget is the first step in this regard. Budgets are prepared for each and every area of the company’s activity such as finances, production, and sales. A company should effectively communicate the budget to all departments of the organization. In this way, the company would be able to exercise control over the functioning of its employees. There are many benefits of a formal budgeting process such as it allows the company to be flexible. It also promotes communication and coordination within an organization. Variance analysis is mainly done on the basis of budgeting. Any deviation from the budgeted figures can be investigated into and the factors that are found can be analysed as non- controllable and controllable factors (Bruns and Waterhouse, 2002, pp. 173-187). Employees can also be motivated by letting them participate in the management of budget. But budget is sometimes used by an organization as pressure creating tools which lead to strained labour relations, departmental conflict over resource allocation, etc. Moreover any particular department also tends to blame the other departments when the targets are not achieved. Budget also tends to take too much time of managers which is not a good thing in a dynamic business environment. If managers are left with too little a time, they would not be able to concentrate on their other activities which are also very much necessary for the functioning of an organization (Stede, 2001, pp. 117-131). So it can be said that it is too time consuming when compared with the value it provides. Moreover we are now living in an ever changing environment. So planning on the basis of the current performance may be unrealistic. When a budget is prepared, certain conditions are always assumed. If those conditions change after the budget was prepared, there could be conflict between purpose of evaluation and planning. It could also create gap between an organization’s short-term and long-term goals, if they are unlinked (Hofstede, 2012, p. 162). The budget also doesn’t take into consideration enough variables to cope with the long-term strategies of an organization. If the conditions under which an organization operates are stable, budget can be used for performance evaluation. But under turbulent environment conditions, it is very difficult to prepare a valid budget. Hence the importance of budget diminishes in a great way. As the competition is very intense and also life cycles have become shorter, future is very difficult to predict and so any long term planning becomes unrealistic for a company because it will be based on uncertain assumptions (Bhimani, Horngren, Foster and Rajan, 2012, p. 207). While preparing a budget, data is collected from the past which is again used to predict the future. Assumptions are made to forecast the future which can sometimes be right and at other times wrong. So a budget can provide us with an inaccurate forecast of future while providing the managers with a sense of security by indicating where the business is heading. Moreover a company is unable to foresee unexpected events and so they are not included in the budget. So the budget is also not able to predict any disruptions in trend and in such situations it becomes useless for a company and leads to a sheer waste of resources for a company (Dropkin, Halpin and Touche, 2011, p. 23). Moreover when market conditions and demands are unstable and difficult to be predicted in advance, budget as a control tool becomes irrelevant for an organization because preparing accurate plans will be in any way not possible. The competitive environment of today and the uncertain conditions render a budget to be of no importance for an organization. It no longer meets the need of an executive for information. Continuous improvement and flexibility are the need for companies that want to survive in today’s competitive environment. Leaders who are comfortable with change, also called “change-leaders”, are the most desirable in today’s competitive environment (Glynn and Murphy, 2008, p. 156). The failure of budgeting in today’s competitive environment is mainly because of the fact that it concentrates on internal activities. The company must first try to cope with the changing environment, for example, meeting the needs and demand of customers which are ever changing. But companies still spend heavily on budgeting though it is unable to cope with the ever changing environment (Husson, 2002, p. 77). The organizations of today must try to improve their management processes by using additional tools such as balanced scorecard. Balanced scorecards, though, when used in conjunction with budgeting process have shown limited success. There are several scholars and executives who have blamed the budget for causing problems (Drury, 2008, p. 379). The way forward is to replace traditional budgeting concept with the concept of Beyond Budgeting. It is not a new management tool but it is just a re-thinking of the way an organization is managed and doing things in new ways. Fraser and Hope introduced the concept of Beyond Budgeting when they founded the company Beyond Budgeting Round the Table (BBRT). It is a complex concept that cannot be easily implemented in organizations. It is a journey that includes reform of an organization and also new principles of leadership (Shim, Siegel and Shim, 2011, p. 143). It sets targets for an organization based on long term and short term perspectives but not on an annual view. There is an ability to adjust to unforeseen events when evaluation is made with hindsight and also relative goals. The organizations that adopted Beyond Budgeting concept make evaluation of performance not only on the basis of fixed targets. It is based on a relative number called KPI and it is not individual based but team based (Coombs and Jenkins, 2002, p. 132). Beyond Budgeting concept creates value for shareholders and customers and are also the primary goals of the concept. The companies stick to a predominant plan in the traditional way of management but in the concept of Beyond Budgeting, the plans can change anytime during a year. It facilitates to adapt continuously to the changes in the demand and preferences in the market. In this process, there is only constant improvement and there are no annual perspectives (Emmanuel, Otley and Merchant, 2001, p. 107). Conclusion The guidelines of KPI are followed in respect to financial ratios and also to make available resources when they are needed. This facilitates optimum utilization of resources. Customers’ preferences and demands are met faster in the concept of Beyond Budgeting. It requires an open system of information where the profitability and costs caused by customers are known to employees. It is beneficial for organizations to resort to Beyond Budgeting concept because budgeting process in this ever changing environment doesn’t seem to work for organizations. It is very difficult to plan for an organization while following a traditional budgeting process. Adapting to change is the key factor for organizations striving to survive. So the Beyond Budgeting concept which is much more adaptable to change must be implemented by organizations, considering the environment which is ever changing. 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