Types of Budgeting Techniques - Citibank Indonesia - Case Study Example

Citibank Indonesia (Student’s Name) (Tutor’s Name) (Course) Date of Submission Introduction Citibank extended into the Indonesian market in 1968. By 1983, the Citibank manager in Indonesia, Mr. Mehli Mistri, purported a lucrative division which tracked the growth of the Indonesian economy. Accomplishing the profit growth correspondence with the economy was a primary objective for opening operations in Indonesia. The government had called for international banks to institute foreign direct investment to upsurge financial and human capital.. In 1983, the bank’s regional managers increased the after-tax profit target from $500,000 to $1,000,000 for the Indonesian division (Newton 2008). This was not in the plans of Mr. Mehli who had earlier submitted a budget aimed at spending more. In the quest to achieve this target, the Indonesia Bank officials centered their decisions on disparate risks, regulatory restrictions, personal competition as well as local growth and competition. When the bank pushed down an increase in net income in 1983, they did not bestow any assistance for up surging risk, nor make changes to the weighted average cost of capital (C.A.P.). C.A.P. states that an up surge of return goes together with an up surge in risk. When the officials increased the budgeted income capriciously without paying much attention to the risk involved, they vitiated the prior accepted budgeting procedure (Newton 2008). Citibank regional officials should have provided a dialog for local and corporate officials regarding the anticipated return and risk characteristics from the division. Citibank Indonesia came under big pressure from the regional management than they had personally aimed for. This essay is aimed at looking at the budgeting procedures used before and after the changes in targets as well as taking into consideration risk factor entailed in the process. It will also focus on best practices by the bank to achieve its new target The budget targets in an organization is what it establishes as its boundaries for the total money it can and should spend on a specific fiend, department or as a whole. The budget’s main objective is to provide guidelines on how tasks need to function with the intention to stay within a maximum goal expenses. Managers play a major role in preparing, implementing, and maintaining the limits of a budget. It is therefore crucial for them to be well informed about all the steps, details and plans entailed in a budget. It is in the best interest for the organization to formulate budgets in the presence and approval of the managers to enhance efficiency and proper functions of the organization (Newton 2008) Types of Budgeting techniques The budget setting process is every so often viewed as either a bottom-to-up or up-down process. A disparity on these methodologies is to ensure that the process is an iterative one, either during its primary developmental phases or through cyclic re-forecasts of the original budget. In every case, administrative management's choice of the strategy to be used will have a far reaching impact (Ray 2008) The budget process frequently influences how the decision making process within the organization is perceived by the employees and lower level managers, how information is distributed and the involvement in attaining the organization's goals (Badiru 1993). These are crucial considerations when making decisions upon a budget process that correlates the organization's structure. Advantages and disadvantages of Using Bottom up Budgeting Approach Bottom-up budgeting (also known as participatory budgeting) is to a certain degree an emerging and modern technique to setting up the utilization of financial resources of an organization. Mainly utilized by larger organizations, it is unlike top-down budgeting where the executives high in the hierarchy make all of the decisions (Ray 2008) Participatory budgeting technique provides the opportunity for employees and junior managers to participate in setting their personal goals and prospects for a specific financial period. It allows them to have ownership of the decisions made in the organization, inspiring them to meet budgetary limits that would otherwise seem unrealistic or unattainable if they were delivered by someone without as much understanding of their day-to-day operations (Klein 2000) Bottom-up budgeting can be utilized to give more accurate than other techniques. When one relies on the employees and managers who will actually participate in the process to help with budgeting, it is more likely to receive better estimates (Ray 2008). These experts have the knowledge of what it takes to get the task completed and they will be close to formulating an accurate assessment than others with no experience or expertise in the project. Bottom-up budgeting in addition can improve employee motivation. When managers and employees have a say in the process of budgeting, they feel more of being participants in the running of the organization and its objectives. Entrusting this duty to employees and managers gives of them a sense of belonging in the major scheme of things. By improving the morale of employees, one can often expect efficiency and better results on projects. One of the major demerits of utilizing bottom-up budgeting technique is that it sometimes leads to additional padding in the figures. While the budget can rarely be short, it will sometimes end up costing more than the scheme should cost. Since specific divisions are in control of coming up with approximates, they will frequently try to pad the figures so they do not have to worry about budget limits (Klein 2000). In case this happens often, it may lead to needless spending. This budgeting technique can also take more time to attain. With this technique, one must rely on each specific scheme manager to come up with an approximate for his/her department. When one has to wait on others to get things done, this can take longer than simply coming up with the budget on your own. Managers are often engaged in other activities and may not have time to stop what they're doing and plan a budget (Ray 2008) Merits and demerits of using Top down budgeting technique This is the technique where budgets are created by starting from the highest level working towards the bottom using parametric relationships. Top down techniques evidently express the operation goals and prospects from the executive management, which sometimes can be idealistic as they don’t integrate the contribution and participation of the very people who implement them. Budgets are at all times prepared by top executive administrators and subjected on the subordinate levels of the institution. A fiscal value is placed on a specified unit (product, service, materials, and labor hour) (Badiru 1993). An approximate of the figure of units needed is finally transfigured to currency by multiplying the quantity of units by the unit value. This type of budgeting technique functions in the conflicting direction to the Bottom-up technique. It begins by approximating the expense of upper level tasks, these approximates are given a higher priority than any others and most times than not limit the subordinate level tasks. The whole process of formulating a budget begins from the executive upper level management and the total approximate for the completion of the project. The budget is then split into between first level of tasks and lower level tasks. It should however be noted that some organizations may split their budget to more than two sections. (Badiru 1993) Department’s managers have more expertise on the fiscal requirements of their specific divisions as compared to the upper level executive management. Formulating a plan on how to utilize the organization’s resources without the participation of all levels can be considered as planning an ineffective budget. This might also cause underfunding and overfunding of some of these departments. In the case of an underfund, it may limit or cause underperformance in retaliation. It may site the inadequacy of funds as an alibi for their poor performance (Klein 2000). The general workforce may in some cases be indignant that their contribution is not taken as significant during the planning process. Departmental heads and managers may in retaliation to this cause tension and working disputes in the working place. (Klein 2000) With the changes in budget spending faced by the Citibank, the institution has a good chance of achieving the limits of the new budget. This is can mostly be attributed to the budgeting technique utilized in the organization. The firm is more likely as stated above to have more motivated and efficient employing hence increases the chances of the success of the new budget (Badiru 1993) Highly Achievable Budget Targets While the use of highly achievable budget targets is the typical observed practice, not all budget targets should be set to be highly achievable. If the organization is in danger of financial distress, top managers may set highly challenging profit targets to signal the short-term exigency. Top managers sometimes also set high profit targets to limit subordinate managers’ discretionary investments. And they sometimes set high targets because they suspect organizational slack or because they want to set up a rationale to replace an ineffective manager. This game playing may involve deceptive accounting practices (e.g., altering reserves estimates) or adverse operating decisions (e.g., working overtime to boost sales and profits at year end, delaying preventative maintenance) (Pamela 2002) The reasons for observing highly achievable budget targets perhaps are the many motivational, planning, and control advantages they have. To begin with, highly achievable budget targets increase managers’ commitment to achieve the targets. Highly achievable targets protect the managers to a certain degree from the effects of unfavorable, unforeseen circumstances and allow them few, if any, rationalizations for failing to achieve their targets (Hotstede 2003) Second, highly achievable budget targets protect the organization against the costs of optimistic revenue projections. The first step in the budgeting planning process is usually the preparation of sales forecasts. If the budgets have optimistic revenue projections, managers will be induced to acquire resources in anticipation of revenue levels that may not be forthcoming (Marc 2006). Some of these acquisition decisions are at least partially irreversible, because it is often difficult and expensive to shed people and specialized assets. It is usually safer to forecast sales relatively conservatively and acquire additional resources when their need is assured. (Hotstede 2003) Third, highly achievable budget targets make most managers feel like winners. In the minds of most managers, budget achievement, particularly when linked to rewards such as bonuses or promotion, defines the line between success and failure. Organizations derive advantages when their managers have good self-esteem and feel like winners. Managers who feel good about themselves and their abilities are more likely to be eager to go to work, to take prudent risks, and to increase their levels of aspiration for the future (Pamela 2002) Fourth, highly achievable budget targets also reduce the costs of organizational interventions by top managers, who typically intervene in the affairs of their subordinate managers only when unfavorable variances from the budget occur (that is, on a management-by-exception basis). When 80-90 percent of the managers are achieving their budgets, top management attention is directed to the relatively few situations where the operating problems are most likely and most severe (Marc 2006) While the use of highly achievable budget targets is the typical observed practice, not all budget targets should be set to be highly achievable. If the organization is in danger of financial distress, top managers may set highly challenging profit targets to signal the short-term exigency. Top managers sometimes also set high profit targets to limit subordinate managers’ discretionary investments. And they sometimes set high targets because they suspect organizational slack or because they want to set up a rationale to replace an ineffective manager (Robert 2004) Again, the fact that the organization uses techniques that involves all the employees’ participation gives it an advantage in trying to evade game playing activities. They have a platform in which they can come together and give good and efficient results free from these activities. Conclusion Budgeting systems provide a way of converting organizational objectives into an organized set of actions associated with specific expectations of results; they facilitate coordination by forcing the sharing of information across the organization; they provide a standard that can be used to evaluate performance; and they have many behavioral implications, both positive (motivational) and negative (dysfunctional), in relation to organizational objectives (Robert 2004) But budgeting is not immune to criticism. For example, critics argue that budgeting processes are rife with game playing (e.g., making slack) and focus mainly on cutting costs rather than creating value. Despite these criticisms, the use of budgets only seem to be gaining popularity and are becoming a big part in all organizations. Their use is most likely to remain an crucial part in the majority of institutions which can be attributed to them being deeply instilled in the system, joining together all the distinct departments in the organization into a functional unit (Marc 2006). It is fair to site however that because an institution formulates a budget, it does not mean that it is participating in useful financial planning. Recognizing specific institution requirement may play a crucial role is choosing the right technique to utilize, this may require expert workforce. Making rational or uninformed decision may lead to costly expensive consequences that could have otherwise being avoided. Bottom-up budgeting technique is in most cases more effective than top-bottom technique, it should however be noted that different institutions require different techniques and each executive decision should be an informed one. 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