Why Traditional Budgeting Is Outdated - Essay Example

Accounting Assignment By Key words: Accounting Accounting Assignment Introduction A budget is a vital financial that involves interpretation and systemic analysis of financial forecast associated with the markets, products and resource applications. Budget formation process requires appropriate planning. It requires financial and operational resource information in making decision. It is usually utilized as a performance measurement tool in most of the organization (Barsky, 2004). The budgetary planning process is conducted every fiscal year. Most managers and other executives have continued to consider the process as a regular process and have in many times adjusted the figures instead of doing thorough assessment of budget in the organization. The traditional budgetary process is ineffective due to the many limitations that are associated with it. The paper seeks to outline the various challenges that are associated with the use of traditional budgets and the need to discard it. Why Traditional budgeting is outdated Traditional budget model is a rigid tool and should be discarded. According to Jack Welch a general electric chairman, traditional budgeting process is considered ineffective management practice. It sucks the fun, big dreams and energy of the organization. He elaborates that company improve many times not because of their budget. Most chief executive managers have continued to utilize other methods of planning are replacing traditional budgetary methods in organizations in the United Kingdom (Wildavsky, 2011). The traditional budgetary model is considered the greatest barrier to organizational changes according to beyond budgeting round table. The companies have been found to be spending a lot of capital to put together the organization’s budgets. Some organizations are taking 6-9 months preparing the budgets and this is considered a waste of time in the organizations. In today’s dynamic knowledge information economy, budgets which were considered meaningful instruments for organizations’ control management are thought to be a danger for the success of the organization. Traditional budgets are believed to hinder flexible and fast adaptation of an organization to the market thereby impairing realization of full potential. They often cause deception, mistrust and endanger corporate transparency that is demanded by most organization in the current world. So many limitations have been encountered while using the traditional budgetary methods. First; it costs too much, it takes a long time and consume more resources of the organization. Budget preparation process may take 6 – 8 months in some organization. The budgets are usually more detailed and need the input of many people in various departments of the organization. A lot of resources in the organization are usually spent in the traditional budgetary planning process. Internal politics in the organization occurs and the focus shifts from the customers to the organization since employees are self occupied. Secondly the traditional budgetary tool is inflexible and fixed, it becomes irrelevant so fast. It usually begins with top down and then bottom up with an intention of achieving the goals set by the organization. No more changes are usually done when after the budget is locked down. During such a period it is perceived that no change will occur yet change of economy may occur, market conditions and industry can change and even some more specific changes (Kung, 2010). New competition and entrants may be experienced in the market; changes in regulations too may be experienced. The organization can experience new concepts, new innovations, new partnerships and many more external and internal factors that may affect the financial system in the organization. The organization may not be able to deal with the changes with a budget that is fixed. A fixed budget only targets the changes at the time when it was being created. A research conducted by BBRT on budgeting, planning and forecasting practices in various organizations revealed that the budgets were useless within the first 6 months in an organization. The ineffectiveness of the budgetary process keeps increasing as the conditions of the market become volatile and the speed of business accelerates. Thirdly, most organization ties employee and executive compensation on their performance toward the organizational budget. The employees are forced to negotiate a budget benchmark that is achievable especially in cases where their performance is related to the organizational budget (Pina et al, 2009). They do this to enable them achieve the set goal. Such an approach impacts negatively on the performance of the organization since it usually results into a gamesmanship of sorts and permit internal negotiations within the organization. The approach rather than creating a budget that aims at achieving the set goals and reflecting the company’s future, ends up being arbitrary and largely fictitious. The traditional budget has been found to be having a lot of limitations and flaws the organization have come up with ways of dealing with the traditional budgetary model. Rolling budget Organization is currently shifting from the application of a traditional budgetary model to rolling forecasts with an intention of projecting into the future. It is usually associated with the organizations’ performance in the past. It is usually to include information and input in relation with the changes in the business market. The approach unlike the traditional budgetary model predicts current situations in the market and is not fixed (Ostergren & Stensaker, 2011). Traditional budgetary model ends at a fixed time unlike the rolling forecast that moves with the time. The approach is considered by the organization as predictable and realistic. Rolling forecast are updated more often unlike budgets which are updated semi-annually and quarterly. The model requires less time to update and is more accurate. The model requires being updated on a short term basis and involves minor tweaking. It saves resources and time than the traditional budgetary method. The approach focuses on performance achievement and outperforming competition from other companies. The organization measures its performance by basing on industry metrics against the industries’ top performers. The companies and the employees get bonuses in situations where the competitors are outpaced. More and more organizations are moving from the traditional budgetary models especially in the European market (Ekholm & Wallin, 2011). The climate in the European markets is usually less regulated and open. Some companies have failed to change from utilizing the traditional budgetary model even though the model is becoming less relevant and vital in the control mechanism of the organization. To improve the performance of the organization, effective transitional tools should be utilized in changing the management philosophy and organization’s culture. The change has to be communicated to the lower management levels. According to Ryan &Bill (2007), traditional budgeting consumes time since the time taken by the organization in preparing the budget each fiscal year is long. Some organization may take even more than seven months. This time can be utilized by the organization in doing other important functions. The method is also considered costly. Despite new innovations including the utilization of computer technology, the budget making process has continued to be expensive impacting negatively to the organization. The budgetary process is only effective in an environment that is unstable and not in an unstable changing and competitive business environment. Shifting from traditional budgeting to zero based budgeting According to Otley and David (2001), zero based budgeting acts as a replacement to the traditional budgetary model since it aims at offering an effective approach of dealing with the challenges and limitations of the traditional approach. Unlike the traditional incremental method, this kind of approach does not begin at the level of the previous budget. The ongoing operations in the company are assessed and continuations are only allowed by considering its usefulness. The executive requesting for the budget is the one responsible for it. The approach permits regular evaluations with an intention of ensuring the company is able to adapt to the changes in the environment. This is unlike the traditional approach that is fixed until the fiscal year ends. Traditional budgeting model has received a lot of criticism according to a survey conducted by Ryan and Bill (2007). The approach lacks flexibility and encourages rigid planning. The model is thought to be ineffective in a competitive world. The budget preparation process takes a lot of time and the employees and executive managers meet the lowest target than focusing on the main target of the organization. The approach makes it a challenge in a competitive business environment. An organization has to compete well by comparing itself with the others in the market. The approach forces the employees to work as per the budget even though the actions may not be desired. The method gives rise to variations in reports which are inadequate living some questions unanswered. The approach focuses on performance that is short term ignoring shareholder value drivers. Traditional budget process utilizes a top down approach yet a well performing organization has to involve employees in the lower levels of management. The employees at the lower levels are to be empowered and the traditional budgetary method should be changed. The study recommends a beyond budgeting approach aimed at providing a way of replacing the traditional method of budgeting. The approach is believed to be flexible and changes with time. The approach does not rely on figures that are obsolete. The allocation of resources to the various department of the organization has to be done in a timely manner. New approach to budgeting A budget that is rolling, incorporate benchmarking with competitors and therefore places the organization in a favorable ground to compete. The new approach will allow the managers to respond to the external environmental changes. The method encourages innovation culture aimed at raising the performance of the organization by dealing with the challenges in the internal and external environment. Unlike traditional budgetary model which focuses on the culture of the organization, beyond budgeting model focuses on the creation of value. The application of the beyond budgeting approach focuses on devolving the responsibilities of the managers. The approach unlike traditional approach aims at beating competitors and not the managers of the other organization (McMillan, 2010). The approach gives clear responsibilities to the individuals through motivations. The rewards are based on the teams and not individuals. The devolution of the responsibilities to the operational management makes it easier for them to respond effectively to the challenges facing the organization. Unlike the traditional budgetary process, the beyond budgeting approach provides open and fast information throughout the organization. Public sectors have found it a challenge in applying current budgetary technique in their organization due its wide flexibility nature. Beyond budgeting approach will ensure the organization shifts from control to reducing politics in the internal organizational environments (Hansen et al, 2013). For the organization to have a flexible budget, change is to be enabled. Sustainable and real change needs a case that is solid for change. While the employees and executives continue to complain on the planning process of the budget, only some are aware that the problems are symptoms of serious and bigger problems that affect nearly all the sectors of the organization. Some are worried of sub optimization and gaming while others complain on the extended time that is utilized in preparing the budget, some considers it a meaningless performance yardstick while the rest argues that the method is slow in responding to the challenges facing the organization. The many concerns and problems are however intertwined. They all arise due to continuous use of the traditional budgetary approach as a tool to be utilized in the management and controlling process. Traditional approach to budgeting ignores reality both outside and inside the organization (Amalokwu & Ngoasong, 2008). Traditional budgetary approach ignores the external business environment that remains dynamic and unpredictable. Most companies prepare budgets with variety of reasons which include resource allocation, forecasting and setting of targets. The targets of the organization are represented by the numbers in the budgets. All these can be achieved in the current business environment by applying the traditional budgetary methods. Comparison power is vital in measuring the performance in the organization (ZHOU & ZHOU, 2005). Organization should be able to compare its performance with other players in the market. The approach is more self regulating unlike the traditional approach that forces managers to set easiest targets that they will be able to achieve faster. Organizations that subscribe to the modern approach of allocating budgets provide flexible and bigger decisions that can help deal with the challenges faced. Traditional budgeting flaws A study conducted by Van der Stede and Wim (2010) on the disadvantages of the traditional method of budgeting revealed that, traditional budgeting method is inefficient and inflexible; it has contributed to most of the corporate scandals that are considered notorious such as WorldCom and Enron. An executive at WorldCom explained at how the fixed budgetary process was unfair for the progress of the organization. Bjarte Bogen an executive at the Statoil Company in Norway admitted that the old budgetary method was ineffective in the current world. He asserted that traditional budgetary system was not the best approach toward running a company of such a magnitude in a business environment that dynamic demanding and more turbulent. Traditional budgetary model is inflexible and outmoded. The approach does not provide suitable ground for making decisions in the organization. Traditional budgets are believed to hinder innovation and changes to the organization. Managers who are entrepreneurs have found themselves in trouble for incurring cost towards projects that were not part of the budgetary plans even though their intention was to boost performance in the organization. Traditional budgets according to the study use up inordinate energy and time (Barsky, 2004). Conclusion Despite the utilization of soft ware tools and powerful computer network, traditional budgetary method is still expensive and time consuming for the organization. The planning process consumes around twenty to thirty percent of the total time of the managers and executives. Game play which surrounds the traditional budgetary process is one of the reasons that have made the process long (ZHOU & ZHOU, 2005). With the many flaws in the traditional budgetary model, organizations should be able to apply new budgetary approaches. Traditional budgetary model has to be abandoned due to the many disadvantages associated with it. Current budgetary approaches should be performance based activity based and adaptive. References Amalokwu, O., & Ngoasong, L. N. 2008. Budgetary and Management control Process in a Manufacturing. Barsky, N. 2004. Organisational determinants of budgetary influence and involvement. Ekholm, B. G., & Wallin, J. 2011. The impact of uncertainty and strategy on the perceived usefulness of fixed and flexible budgets. Journal of Business Finance & Accounting, 38(1‐2), 145-164. Hansen, S. C., Otley, D. T., & Van der Stede, W. A. 2003. Practice developments in budgeting: an overview and research perspective. Journal of management accounting research, 15(1), 95-116. Kung, F., Huang, C., & Cheng, C. 2010. An examination of the relationships among budget emphasis, budget planning models and performance. Management Decision, 120-140. McMillan, E. J.2010. Zero‐Based Budgeting. Not-for-Profit Budgeting and Financial Management, Fourth Edition, 183-184. Otley, David .2001. Extending the boundaries of management accounting research, British Accounting Review, 33, 2001, pp. 243-261. Ostergren, K., & Stensaker, I. 2011. Management control without budgets: a field study of ‘beyond budgeting’in practice. European Accounting Review, 20(1), 149-181. Pina, V., Torres, L., & Yetano, A. 2009. Accrual accounting in EU local governments: one method, several approaches. European Accounting Review, 18(4), 765-807. Ryan, Bill .2007.Budgeting, the individual and the capital market: a case of fiscal stress. 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