The Traditional Budgeting Model - Case Study Example

THE TRADITIONAL BUDGET AS A RIGID TOOL AND SHOULD THEREFORE BE DISCARDED IN PRACTICE Lecturer’s Introduction The traditional budgeting model has been utilized by organizations worldwide since the 18th century as a tool that the management utilizes for applying internal controls in the organization, management of strategic objectives, keeping the company on track, a motivating tool and as well as a tool for employee performance. The tool has proved to be a successful model in running organizational activities but has passed the test of time. However, recently, other models have been introduced calling for calls of dumping the model in a snap as it is a strict model, based on shaky grounds and as well utilizes very aggressive principles. A number of organizations have been utilizing the model and has been proved to contain several problems and weaknesses. According to critics, the model is a very strict model and organizations needs to have flexibility of being able to act quickly to any organizational changes in the market conditions that the model does not allow. Most of the model criticism has been based on the notion that the model that utilizes a rigid annual budgeting system enslaves the organizational under it (Otley 2001, 245). The whole process of budget preparation is considered as hazardous and has been considered to provoke dysfunctional organizational behaviors by the organization manipulation of figures and numbers in order to ease the objectives of the organization. The model focuses on targets that are based in incremental changes in organizations based on the previous period resulting to a result that is inwardly comfortable yet outwardly, it is difficult to achieve. The model cannot support sound organizational, financial decision-making because it does not accurately reflect organizational full cost of individual services and projects ; thus, it is considered as a barrier of innovation and change in the organization. Managers will find themselves under great fire for incurring other costs on projects that were not included in the budget (Van der Stede 2001, 118). The traditional budget model takes a long time, cost too much and will consume many organizational resources to produce. It is fixed, inflexible and will quickly become irrelevant with time therefore it is not fit for purpose. Traditional Budget Model When the word budget comes into the mind, what comes into the mind is a long sheet that is of full of numbers. However, there is more that is beyond the numbers. The budget is not only a quantitative tool but is a qualitative tool. It is however important for the management as a planning device as well helps in assigning employee duties and employee performance evaluation. The traditional budget is used in ensuring that the internal control system in an organization is applied in the organization (Van der Stede 2000, 612). It has been used as a tool for motivating the employees by unifying all organizational departments in the organization to enable attainment of the organizational goals by communicating together as and sharing information. It is also important in motivating employees and the management by making them feel appreciated by the year-end incentives offered. Although the model is imperfect, these advantages make it be still underutilization until today by external and internal users. Internally it is used to distribute tasks among the employees and acts as a performance tool for measurement as well as a way of ensuring internal organizational control systems are applied. According to Otley 2001, there are a number of advantages that have been associated with the budgetary model. It enables decisions to be made on historical data that is based on facts and reliable information and organizations members will easily calculate the expenditures and revenues using line items. It also ensures that money is spent within the company ability and is spent for the purposes speculated. It is also easily adapted; therefore, different corporations under different economic conditions can use it, and it helps the company utilize its funds by financial control. However, the traditional budget model is based on solid grounds as it is based on the general ledger. A ledger is a group of accounts that the company maintains containing the assets, liabilities as well as the stockholders equity accounts. Therefore, the ledger is a strong base used as it entails all the financial information of the company and how the changes in certain accounts have an effect on the company’s position. Ittner & Larcker (2001) summarized the advantages of the model as planning cash flows, controlling costs and activities as well as planning for the desired organizational position. Broadbent & Laughlin (2009), states that traditional model budgetary system creates long term actions of the organization as goals are arranged within the budget and designs and short term plans are created without hiding any organizational future responsibilities i.e. everything is placed out on the table upfront and actions are taken for applying the set up plans. As a model, most of the disadvantages enlisted by the critics who condemn the model states that it is time consuming, it has a top to down system of command and the management centers controls approach as well decision making. The model is created with an emphasis of reducing organizational costs rather than increasing the organizational value (Muhammad Dahlanm et al. 2007, 83). Too much time is however used in budget creation for the next financial year and then organizations are bound to get frustrated that it gets out of date as the year gets finished. According to studies undertaken by Congqin (2007), the results revealed that the model consumes around 20 percent of the management time, therefore, it is termed as a time wasting budgetary model. Criticism of traditional budgeting Traditionally, the model has been one of the central financial processes used by organizations. It has however grown to be one of the main targets of critics in the accounting process. Despite the stance towards budgeting that can be taken, it agrees that the business is not what it is termed to be when the budgeting concept was created. The change has made market extremely competitive, volatile, and customer driven in contrast to the old stable markets that were more supplier driven. The budgeting has been considered as the most ineffective practices in the management of an organization as it sucks the time, energy fun as well as the big dreams out of the organization. Other methods of planning are replacing the model such as roll forecasting and continuous planning and the trend is making its way across the pond as companies realize that more adaptive planning approaches are the best way of setting their future in the course (Van der Stede 2000, 120). The traditional model of budgeting is a great barrier for change in the organization. A study conducted by Libby & Lindsay (2010), revealed that an average billion-dollar company spends as much as 25,000 person’s days million dollars in putting together the annual budget. The model has also been proven ineffective as it prevents fast and flexible organizational adaptation to the market so that full organizational potential is not realized. Thus, it has been speculated to promote mistrust, deception often and endangering the external corporate transparency demanded by organizations in today’s organizations. Time related constraints The process of making a budget takes a lot of time and energy. Despite the powerful advent use of computers and other softwares, budgeting is a protracted and expensive process. It is usually a quite long and heavy process. For some companies, it may take four to eight months on average. Usually the process and related activities and tasks takes up to 20 to 30 percent of the manager’s times that can be extremely costly and time consuming to the manager since such time can be utilized in other beneficial activities for the benefit of the organization. However, considering the amount of time consumed it adds only a little value to the company. Most of the organizations and corporations conduct their budget on a yearly base, thus, the timeframe can be considered to be too long for a modern business environment, a manager is bound to spend six to eight percent of their work activity time in budgeting activities (Benscoter & Vitt 2007, 156). The time spent, however, increases with the size of the corporation as well as in how much of the time that the managers want to devote to budgeting. Many corporations on a calendar year start the process in the summer, and it will not be over until December and may extend to the period of budget start. The reason for the amount of time that is wasted is the game playing that surrounds all the entire process. Process related constraints The process of traditional model budget preparation is quite tiresome as it is related to the management philosophy of the organization, therefore, are not flexible processes. In most of the instances, budgets take an incremental approach where the budgeted figures are created using prior year actual plus or minus figures (Schmidt 1992, 105). Problems are bound to arise if the lower level budget no longer represents the managers take on the upcoming fiscal year. There is no strategy based on preparation of the budget as it is only based on an incremental approach that disconnects the budget from the company’s strategy since the figures are derived from the previous year’s corresponding statistics. The approach creates problems with expenses when the budget is based on previous figures as the managers feel the need to spend the year’s budget so as to secure the same amount of money for the next fiscal year (Robinson 2009, 8). The old model of budgeting does not provide opportunities for change. Unpredictability in the market has increased as new markets and company’s development emerge, and customer loyalty has reduced as compared to the days when traditional budgeting was the preferred budgetary option. Organizations need to react to these changing conditions. However, adaptation needs to be slow due to the fixed nature of the budgets. As the process only reflects what is acceptable and appropriate at the moment, traditional budgeting model steers focus away from alternative targets and processes that could be beneficial for the company. According to a study conducted by Neely et al. (2003), supported the notion that the unforeseen changes in the market makes it difficult to create accurate budgets. From the study results, companies considered budgets to be of only somewhat useful important to adapting to changes bound to occur to the enterprise as only a few organizations will be able to revise their budgets when needed to acquire resources outside the budget. Thus, the process involved is a more fixed process and does not offer flexible opportunities for change (Van der Stede 2000, 621). It is fixed and inflexible The traditional budget model starts from the top to down to become a detailed bottom-up process of meeting the fixed goals that are set up by the management whether they are realistic or unrealistic. One a budget is made and passed down by the management; then it becomes locked down and it is a game over for any adjustments, however, how much the economy, market or the industry conditions may change. However, new regulations may roil the game and new to entrants and competition may emerge. There are a new partnership, concepts innovations and other internal factors that have financial repercussions to the organization that is bound to arise. So many things are bound to change yet the budget only looks at the same things and will assume that things will remain as they were back then when it was created. According to a survey conducted by Miller & O’Leary (2007), found out that 61 percent of respondents working in different organizations found out that budgets were very different from the actual results and could be termed as useless within the first months of the fiscal year. This trend is on the rise as market conditions are becoming more volatile as a result of the accelerating speed of enterprises and businesses. Majority of the companies are involved in combining employee compensation and executive directly to performance against the budget. As a result, the employee’s goals focus on how they can minimize the performance expectations set in the budget. The easiest way of controlling such an instance is negotiating an overly achievable budget benchmark. If managing a cost center that is responsible for spending, the manager will try to maximize the size of the budget spent as much as possible because it provides the most resources for spending regardless as to whether the resources are necessary or not (Ryan 2007, 391). However, a manager in a revenue-producing center is likely going to lowball the budget so that when they exceed it, they look good. The emphasizes of achieving the set goals in the budget creates dysfunctional behavior and gaming and complicates the cooperation within the organization as the team focuses is on attaining their own budget. The kinds of problems will arise especially when the budgets are used for measurement of performance and personal target setting (Player 2003, 6). This hyper emphasizes the importance of the budgeted objectives and entices the organizational managers to manipulate their figures in favor of the budget objectives or figures that were budgeted. One of the most prevailing issues in budget making is setting up figures deliberately too high or too low. Low objectives are problematic as when the objectives are met; there is little psychological and monetary reward that remains for the managers to exceed the set target. Therefore, managers and organizational members main focus in meeting the set target and once they are achieved there is little effort put on attaining more until the next budget is set (Van der Stede 2000, 619). On the other hand, setting aggressive stretch goals is equally hazardous for the organization. When it is noted that the budget objectives cannot be reached, the managers may want to push the revenues to the next fiscal year letting the ongoing year fall short as the year has been lost that is not good for the company’s progress. A company should strive to achieve best goals always without out limits to ensure success. Traditional budgets are considered as fixed performance contracts to which the subordinate performance is measured upon. When organizational managers realize that their bonuses are based on the budgeted objectives, problems in the organization are bound to arise (Frow et al. 2010, 442). The managers will set the budget objectives as low as possible as a solution to getting their bonuses and the manager will try to achieve the objectives regardless as to whether the company suffers in the process or not. In achieving the goals set, managers emphasize on those metrics that relate to their bonuses. When the goals are achieved, they will tend to reallocate costs and delay revenues so that the next bonus cycle receives a positive effect. Such kind of instances symbolizes how the traditional budget is rigid and, as a result, can change the operational characteristics in the organization leading to higher costs in the near future for the organization (Ryan 2007, 388). Conclusion The traditional budgeting model has been utilized by organizations worldwide since the 18th century. The tool has proved to be a successful model in running organizational activities but has passed the test of time. According to critics, the model is a very strict model and organizations needs to have flexibility of being able to act quickly to any organizational changes in the market conditions that the model does not allow. Traditional budgeting has been considered as not only inflexible and inefficient but as a borderline evil that has contributed to notorious corporate scandals in organizations. The budgeting model is an anti-growth that lowers performance, waste time and causes lost opportunities in the organization. The model is sophisticated, and organizations and companies need to refocus on other budgeting models. References Neely , A., Bourne , Mike & Adams , Chris , 2003. Better budgeting or beyond budgeting? Measuring Business Excellence, 7, pp.22–28. Benscoter, B.W. & Vitt, D.H., 2007. Evaluating feathermoss growth: A challenge to traditional methods and implications for the boreal carbon budget. Journal of Ecology, 95, pp.151–158. Broadbent, J. & Laughlin, R., 2009. Performance management systems: A conceptual model. Management Accounting Research, 20, pp.283–295. Congqin, Z., 2007. Comparison of Performance Budget and Traditional Budget. COMPARAISON ENTRE LE BUDGET DE PERFORMANCE ET LE BUDGET TRADITIONNEL., 3, pp.71–75. Frow, N., Marginson, D. & Ogden, S., 2010. “Continuous” budgeting: Reconciling budget flexibility with budgetary control. 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