Formal Budgeting in a Dynamic Market Conditions - Literature review Example

Management Accounting Management Accounting Business entities and Corporation’s activitieshighly rely on budgeting as it allow the organization to manage its financial resources according to performance and contribution of the business segment. Formal budgets provides overview regarding estimated costs and revenues that may be obtained through the business activities, it involves lists of expenditures, returns and revenues (Rankin & Sayre, 2000). The process to make the list of cost requires a lot of time, by the time of its application the anticipation on which the budget is prepares may become outdated. This document critically analyzes formal budgeting in a dynamic market conditions (Simson, 1990). In addition, it determines the effectiveness of budgetary control in a dynamic environment. It also provides an overview about the solution that may be adopted when the planning based system fails (Rankin & Sayre, 2000). Organizations extract information and data from the market to manage their finances for a certain objective. Budgeting is the activity to manage the organization’s financial resources for the purpose. Corporations and business entities prepare budgets through a process referred to as the budgeting process (Libby & Lindsay, 2003). Organizations prepare formal budgets by determining and managing costs incurred by engaging in the business activity. Preparation of budgets is one of most significant part of a business process. It allows the organization to manage its resources effectively (Rankin & Sayre, 2000). Formal budgets are the list of the expenditures, revenues, returns and profits that are predicted through the business activity. Organizations immensely rely on the formal budget to perform its business activities because it paves as a tool to determine and control (Gervais et al., 2011). Therefore, the formal budget requires approval from the management and committee of the organization to persuade it activity. The conformity from the top management allows the organization to structure its planning and operations accordingly and set corporate goals (House et al., 2002). In addition, it provides projection of sales, cost of sales, overhead costs, operating costs, and future capital requirements that are required to achieve goals (Stedry, 2011). The formal budget is often reviewed monthly or quarterly to track the performance against budget because it is a road map for operations for the financial period (Rankin & Sayre, 2000). Scholars argue that the formal budget is an irrational approach and gets outdates. In order to make accurate projection about sales, operations and costs of the organization, it is essential to obtain realistic and quantifiable projections (Gervais et al., 2011). If these projections do not address the historical pattern then they may adversely affect the planning for which management is accountable (Rankin & Sayre, 2000). In the contemporary period, a rapid change in the market conditions immensely influences the costs and expenditure that are anticipated at the time of preparation of budget (Gervais et al., 2011). This is because of the reason that projections are made referring historical changes but in the current period the uncertainty, such as high inflation rates, legislative changes, and taxation policies etc. affect the estimated projections rapidly. For an instant, at the time the budget is prepared the estimated overhead costs were $20,000, but due to petroleum hike the expenditure raises to $30,000. This projection of the overhead costs affects the transportation expenditures as a result the proposed budget may vary with the current costs that the organization incur (McKinsey, 2011). Budgetary control plays a significant role for an organization to provide a comprehensive overview about the plan for different purposes, emphasizing performance planning and evaluation of actual results (Gervais et al., 2011). The effectiveness of budgeting control has become of the major issues in the contemporary times (McKinsey, 2011). Studies suggest that multinational organizations shall use different budget process that respond to the domestic and foreign subunits because of the diverse environment, it involves strategic planning, demographic and socioeconomic condition (Gervais et al., 2011). This is because of the reason that the domestic market conditions vary with the foreign market condition. Several scholars and study show growing dissatisfaction towards budgetary controlling techniques (McKinsey, 2011). It has been observed that the companies operating in rapid changing market conditions are less inclined towards the use of budget (Ravenscroft & Drake, 1999). This is because of the reason that the annual financial budget focuses on the short-term perspectives and cost saving strategies to meet the objective. It does not address the changing that may encounter during the period. As the budget focuses on the short-term goals it prevents the organization to function in the long-term value added strategies. This may be ineffective approach of the organization to perform operations in the long run (McKinsey, 2011). In addition, it affects employees’ performance and behavior (Libby & Lindsay, 2003). The fear to not to meet their targets or objective may lead employees to adopt manipulating behavior that adversely affect the organization. Libby and Lindsay (2010) study highlights that the budget does not respond to unpredictable environment (Gervais et al., 2011). Therefore, spending too much time on the preparation and forecasting the budget is a time consuming process. If any unpredictable change is encountered the budget does not address the issue, which may loss the objectivity of the budget plan (Ravenscroft & Drake, 1999). In order to address unpredictable changes, the organization adjusts and improves the budgeting process to enhance its objectivity and meet the challenges (Gervais et al., 2011). Hansen (2003) argues that the organization operate in unpredictable circumstance are found to be dissatisfactory with the budgets (Stedry, 2011). According to the study of McKinsey (2011), unexpected events in the market cannot be foreseen and are not incorporated in the budget plan (McKinsey, 2011). Therefore, the budget cannot predict any change in the trend that may be encountered during the operating period. The decision provided by the budget plans are only affective when the market trends are same, incase of any disruption and unpredictable incidents the budget becomes less effective and leads to waste of resources and material. The market demands are unstable and fluctuate with the external influences, as the demands cannot be determined in advance it is impossible to prepare plans to meet the upcoming challenges (House et al., 2002). Therefore, budgetary control tools shall not be as useful. A budget looses its objectivity as soon as it does not provide accurate information to the managers to make decisions (House et al., 2002). Therefore, the organization shall emphasize to overcome the changes instead of focusing and following the decision provided by the budget. It is states that the formal budgeting techniques is static and does not supports centralized decision making due to which plan refrain adoption of new strategies to correspond to the new changing environment. As a result, it stops the executive to respond to the new conditions because of inflexibility to adopt decisions to address the changes (Gervais et al., 2011). Under the fluctuation condition it is suggested that decentralizing organization is effective, through this the employee response faster with the changes sustaining in the market (Ravenscroft & Drake, 1999). Strict strategies and controlling policies makes difficult for the organization to address the dynamic environment. Therefore, it requires more skilled managers and executors to take the responsibility (Ravenscroft & Drake, 1999). In the current times, the business environmental conditions are more uncertain as compared to the previous times (Ravenscroft & Drake, 1999). This is because of the reason that consumer demands, socioeconomic conditions, and political scenario in the region are highly fluctuating. In order to meet the changes in the market absolute guideline refrain flexibility and abilities of the managers to take actions. Several scholars argue that the budget creates problems for the executives; this is because of the reason that they are compelled to make a decision as directed through the budget plan (House et al., 2002). In case of any change in the environment, the management does not has an alternative to overcome the issues. Hope, Fraser and Wallander (2003) suggest that the ‘Beyond Budgeting’ concept shall be incorporate in the management tool (Weygandt et al., 2009). This provides a new dimension to manage the operations and implement new strategies to persuade operations. It suggests that the organizations shall abandon the annual budget process and budget. In order to meet the new challenges, managers are required to revise plans with the stimuli (Ravenscroft & Drake, 1999). In other word, decentralization and more responsibilities were assigned to the employee to enhance diversity of its employee (Zaccaro & Klimoski, 2002). In addition, short-term targets shall be abundant; perhaps long term contracts and targets shall be the primary concern while preparing budgets (House et al., 2002). As it enhances the performance of the employees and incorporates value add services and products to empower its employee and create high performance (McKinsey, 2011). It is also recommended that the organization may set targets on short and long term with the ‘relative and external benchmark’ and ‘relative to internal peers’ this allows the organization to determine the performance of employee and improves operations (House et al., 2002). There should not be fixed targets for the organization. The use of Key Performance Indicators shall be incorporated in the business operation that improves employees’ performance and overcome the game play of workers (Gervais et al., 2011). List of References Gervais, S., Heaton, J.B. & Terrance, O., 2011. Overconfidence, compensation contracts, and capital budgeting. The Journal of Finance, pp.1735-77. House, R., Javidan, M., Hangues, P. & Dorfman, P., 2002. Understanding cultures and implict leadership theories across the globe: an introduction to project Globe. Journal of world business, 37(I), pp.3-10. Libby, T. & Lindsay, R.M., 2003. Budgeting an unnecessary evil. CMA Management, 77(1), pp.30-34. McKinsey, J.O., 2011. Budgetary Control. Illustrated ed. Charleston: BiblioBazaar. Rankin, F.W. & Sayre, T.L., 2000. The effects of performance separability and contract type on agent effort. Accounting, Organization and Society, 25(7), pp.683--695. Ravenscroft, S.P. & Drake, A., 1999. Cost system and incentive structure effects on innovation, efficency and profitability in team. The Accounting Review, 74(3), pp.323-45. Simson, R.L., 1990. The role of management control systems in creating competitive advantage: New prespectives. Accounting, Organizations and Society, 15(1), pp.127-43. Stedry, A., 2011. Budgetary Control: A Behavioral Approach. Reprint ed. Charleston: BiblioBazaar. Weygandt, J.J., Kimmel, P.D. & Kieso, D.E., 2009. Managerial Accounting: Tools for Business Decision Making. 5th ed. Charleston: John Wiley & Sons. Zaccaro, S.J. & Klimoski, R.J., 2002. The Nature of Organizational Leadership: Understanding the Performance Imperatives Confronting Todays Leaders. 12th ed. New Jersey: John Wiley & Sons. Read More