Budget-Based Performance Evaluation Systems - Literature review Example

Budget-Based Performance Evaluation Systems Student’s Name: Instructor’s Name: Course Code: Date of Submission: Introduction The objective of any organization is to deliver good results which can be evaluated against the predetermined goals and objectives. However, what is emerging as a big challenge for many of the organizations operating in the 21st century is the inability to carry out a comprehensive evaluation of their performance by looking at how their departments and business units are fairing. This problem has been enhanced because of the traditional-based approach to evaluation which entirely makes use of organizational budgeting systems to do performance evaluation (Behn & Riley 1999). The major weakness with this approach is that it does not take into account such factors as nonfinancial and environmental factors. The traditional budget-based approach to performance evaluation in organizations is more concerned with financial figures and forgotten to address important issues that affect the performance and that are not financial like market conditions and employee turnover, engagement, commitment, satisfaction and motivation all of which are very important in determining organizational outcomes (Anheier and Leat 2006). The purpose of this essay is to undertake a detailed analysis of the concept of budget-based performance evaluation systems in organizations by looking at particular issues that constraint its effectiveness and that have not been given required attention and which include nonfinancial and environmental factors. Further, this article will address issues related with identification of nonfinancial information, linkage to organizational performance and their consequence in generating dysfunctional behaviors. Impinging factors to performance evaluation Despite the good intention by organizations to determine the performance of various departments and business units in an organization, as a matter of fact, a number of factors come in to be serious challenges to ensuring effectiveness in performance evaluation. The major issues that have come to affect the process of evaluation of performance in organization, is the existence of the nonfinancial and environmental factors that have a very significant role in determining the effectiveness of performance evaluation (Erkki and Laitinen 2004. In most cases, organizations, while engaging in the developing various systems to evaluating performance, thy pay more attention more attention what each and every department and business unit contribute into the overall organization performance and how they affect issues related to planning and control. This approach creates an avenue for leaving important issues such as environment in which the business operates in and the nonfinancial forces such as employees’ factors which have significant role in the performance of the orgnisation (Rees and Sutcliffe 1994). Financial factors Financial factors in budgeting include the allocation of financial resources to the various departments and business units with the aim of making returns. In performance evaluation, financial factors entail those resources that will be consumed by respective departments and their final outcome to the business. In doing performance evaluation, financial factors apply the use of financial figures like profits and costs to gauge how good various departments are doing. Under the traditional budget-based performance evaluation such factors as salaries, company supplies and travel expenses at departmental level were guarded to protect organizational finances from misuse. The basics of budget-based performance evaluation include objectives, performance measures and linkage of objectives with performance measures to determine how well the organization has been performing in terms of profits (Miller et al 2001). Non-financial factors Under the budget-based performance evaluation approach, organizations typically use the budget to evaluate the performance functional units, departments and business units. The common feature with this approach is that it makes use of the financial figures than any other factors. This is despite the existence of other factors that can be used to evaluate the performance of the organization. According to (Erkki and Laitinen 2004), for both the management and the auditors to carry out a comprehensive performance evaluation, the budget –based approach to performance has to be replaced with the one that incorporate all factors both financial and nonfinancial. Using a variety of information rather than financial figures alone helps in intermarrying various metrics both from financial and nonfinancial in order to develop an effective performance evaluation system. Nonfinancial factors that have been missing in many organizations in developing effective performance evaluation systems include lack of incorporation of customer satisfaction, retention, effectiveness of marketing programs, market reputation, brand perception and employee satisfaction and retention (Levy and Williams 2004). This is especially important in ensuring that apart from rating the performance of a department, function or unit, the existing interrelationships among different factors are positive and sustainable. This is because applying financial figures only to evaluate the performance of the organization, may clearly foretell about the business uncertainties which may turn the financial figures into negatives a very short time (Behn & Riley 1999). The support for inclusion of nonfinancial metrics in performance evaluation according to the recent findings by Deloitte, despite embarking on several attempts to do effective performance evaluation, many directors and executive boards are still in dark as they clearly tell the health status of their companies. This is because they lack high quality nonfinancial data which they can act upon. The findings, further, revealed for the future performance of the organization to be effectively determined, metrics to measure both leads and lags have to be present. However, even though many of the board members according to the report showing understanding of the importance of having nonfinancial metrics, a view of them can access nonfinancial information (Deloitte 2007). Even though many of the executives and company directors are under very serious pressures to utilize nonfinancial elements in performance evaluation, still very view have shown the interest to make such brilliant decisions. This is because many of them seem not to have planned and controlled ways to collect nonfinancial information. This is what has been a major challenge for many organizations today. Deloitte believes that for any organization to adapt a quality and effective performance evaluation systems, then adopting the use of non-quality financial information is of great essence or other else the business strategy which is depended on planning and system controls is likely to fail even with minor shocks that are always possible in the operating environment. In general, nonfinancial information immensely contributes to the competitive edge at the market place as it adds some value to both operational and financial performance of the business (Pandey, 2005). Environmental factors The environment in which the business operates also is a very big determinant in the performance of any organization. This is because the operating environment comprises various forces which have direct impact on the direction of the organization in terms of performance. The environmental factors include those forces that cannot be measured in monetary figures but whose contribution to organizational performance and evaluation cannot be underlet (Nielsen et al 2000). The environmental factors can be determined in terms of trends. Environmental information includes data about the customers, competitors, government and the natural environment. Having detailed data on these factors according to (Boswell and Boudreau, 2001), is likely to reflect a true assessment of the company’s performance and its sustainability into the future. This is because the dynamics in the operating environment like competition, customer demands and change in legislations all have direct impact on the performance of the organization. Supply chain is also one aspect of the environment that should be incorporated into performance evaluation systems. This is because it entails the extent to which suppliers relationships are being developed, customer queries managed and how services and products are delivered and returned (Grizzle, 2001). This is especially important in determined if for sure that reflected financial performance is likely to be sustained or not. With the concept of corporate governance, it’s now increasingly becoming very important that as many organizations struggle to have a competitive edge, they also ensure that they contribute positively to the society and the environment in which they operate. This whole idea can by summarized in the company’s responsibility to the environment and the society. For example, while evaluation takes the initiative to determine the performance of each department and business in order to help on planning and control: it is emerging concerns about carbon emission; waste disposal and environmental stewardship are being raised. These factors have been a major obstacle to developing effective performance evaluation methods as it is always not easy to evaluate the environmental factors in monetary terms so as to be to relate with the performance of the organization (Deloitte, 2007). This has been so difficult given that in the environment the fact that the organization has very little control over it. Broadening of performance evaluation approach Despite the need to develop an integrated approach to performance evaluation in organizations by incorporating financial, nonfinancial and environmental factors, serious issues are being raised on how the process will work. This is because it is not clear how to identify the various nonfinancial and environmental factors, link them to desired performance outcomes and manage the likely dysfunctional behaviors that are likely to be caused by the approach (Rigby 2001). In the case of identifying the nonfinancial factors for instance, it is becoming very difficult to incorporate the interests of various stakeholders into the performance evaluation systems and determine which should be considered during planning and which should not (Grizzle 2001). The government, customers and the market and employees are some of the important stakeholders to incorporate in performance evaluation systems. On the other hand, because some of the factors cannot be determined in monetary figures, it is not easy to link them to how they will contribute to the achievement of the desired outcomes. Finally, nonfinancial inclusion into the performance evaluation systems, may require that the executives be very vigilant in seeing what the various functions are doing however, what this is likely to cause to an organization, is kind of some resistance for the feeling that some independencies may have been stepped on by the senior managers (Boswell and Boudreau, 2001). Conclusion This essay has tackled various issues related to performance evaluation systems in organization by looking at the commonly used approach which is budget based performance evaluation. However, despite this approach being very common in many organizations, it is still not easy for many of the executives and managers to tell clearly on the health status of their organizations. The cause for this is lack of incorporation of nonfinancial and environmental factors to the performance evaluation systems. The problem has also been hasted since by the fact that both nonfinancial and environmental cannot be expressed in financial figures and then linked to the intended performance results. However, it is arguable that incorporate both nonfinancial and environmental factors into performance evaluation systems, it is always to have a clear picture of the company’s health status. Reference American Institute of Certified Public Accountants (AICPA), 2001, Performance measurement practices survey results, New York, AICPA. Anheier, H and Leat, D 2006, Creative Philanthropy. Towards a New Philanthropy for the Twenty-First Century, New York, Routledge. Banker, R., Potter, G & Srinivasan, D 2000, An empirical investigation of an incentive plan th at includes nonfinancial performance measures, The Accounting Review, 75, p. 65-92. Behn, B & Riley, R 1999. 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