Budgeting as Still a Very Popular Management Process - Coursework Example

Budgeting is still a very popular management process. Introduction A business organisation whether in the corporate sector or SME sector has certain objectives such as how much to sell and how much profit to be earned for the year. Before estimating sales, it has to asses the market demand for its products. In the survey of demand for its proposed products, it obtains a fair idea of its market share and if its production capacity permits, the organisation will arrive at the quantum of sales that can be achieved for a given period. Once the selling quantity is estimated consistent with its production capacity, the company must plan how to achieve the sales. The quantity to be sold is valued and that will be the sales for the year. The planning process includes budgeting of allocable resources for various activities such as purchasing, manufacturing etc. Hence, budgeting is defined as the planning process for use of resources of an organisation and allocating among the planned activities for accomplishing the ultimate objectives of the organisation (LSE.CO.UK) A budgeting process, therefore, starts with the setting up of principal budget or limiting budget factor also known as key budget factor and this is what enables the company to plan activities in furtherance of the key budget factor. Pursuant to this limiting factor, sales budget, production budget, purchasing budget, labour budget, cash budget, and other budgets for expenses administration, research and development, selling and distribution, capital expenditure, and working capital budgets are prepared. It will now be clear, therefore, that budget is a formal statement detailing financial resources allocated for putting into action various activities for the given period. A budget is prepared so that control can be exercised by monitoring the performance and comparing the actual figures and arriving at variances so that reasons or variance i.e. excess or shortfall are ascertained and remedial actions are taken. This is known as budgetary control as a technique of comparing actual results with the budgeted amounts. Four types of responsibility centres headed by a manger are generally set up for the purpose. They are revenue centres, expense centres, profit centres and investment centres. Thus, budgeting and budgeting control enable management of the company to think about the future, which includes looking ahead, setting up of detailed plans for achievement of the targets and giving the organisation a sense of direction. It also promotes co-ordination and communication, fixes responsibility and provides a basis for performance analysis looking at the variances from the budgeted figures that facilitates remedial action for any shortcomings and motivates employees by making them participate in the process of budgeting and control. The budgeting has some disadvantages too. It forces employees to conform to budgets, which results in strained employer-employee relationship and manipulation of records by the employees to avoid criticisms from the management for shortfalls in targets. Conflicts between departments can also arise resulting in their operating as watertight compartments. Besides these, there are specific disadvantages challenging the very purpose of budgets, which shall be seen later in this paper. Therefore, in order to be an ideal budget, it should involve people of the organisation in its making, cover the whole organisation, set up standards of performance and have flexibility to provide for changes as and when necessary. There should also be continuous feedback and monitoring and variance analysis periodically. (Chapter 4 Budgetary control) . The need to deviate from traditional budgeting process The financial and functional orientation of budgeting has made it out of place in the era of activity-based approaches, benchmarking and balanced scorecard and in view of fast-paced globalisation, shorter product life cycles and technology innovations and customers who are becoming more and more sophisticated to apply simulating environments. These developments have rendered the traditional budgeting process lacking in many areas. The experts feel that data requires further analysis, finance and line managers should make meaningful commentaries, there should be more non-financial measures and the budgeting process is not just to control expenditures. The annual budgeting is not suited to all types of industries. Hence, managers must think about the need to deviate from the traditional method of annual process consistent with industry’s unique requirements. For example, retail fashion sector has the shorter time-scale of months or weeks instead of one year and in the case of regulated utilities, it can be more than 10 to 15 years.(Fanning 2007) It has been estimated that an average of 25,000 man days are required for every billion dollars of sales budgeting. Needless to say therefore budgeting methods are time consuming and costly. About twelve shortcomings in traditional methods were identified by a research sponsored by Accenture by a UK based Cranefield School of Management in 2001. Viewed in three different perspectives of competitive strategy, business process and organisational capability, they range from unresponsiveness and lack of flexibility preventing change, being bureaucratic and having no scope for creative thinking to focussing on vertical command and control without recognising network culture that is emerging in organizations and making people concerned feel undervalued. The improvements suggested are for adoption of activity based budgeting, zero base budgeting, value-based management, profit planning, and rolling budgets and forecasts. The research has cited some case studies. Scandinavian group of companies that include the largest bank in Sweden Svenska Handelsbanken which gave up traditional budgeting as early as in 1970s, has been enjoying more return on equity than their rival banks by adopting benchmarking against its rival companies for more than 33 years now. One of the largest producers of polyolefin plastics Borealis A/S in Denmark dispensed with budgeting from 1996, switched over to rolling forecasts, and balanced scorecard. They do forecasting once in a quarter that rolls for five quarters and plan resources for not more than 10 days at a time. Skandia, a financial services company having more than 7,000 employees devolved responsibility to operating companies and only focussed on high-level budget estimates. Instead, it now applies scorecard for its management of business. It gives quarterly bonuses for both financial and non-financial targets. Even outside Sweden, corporates such as Shell, BP, Astrazeneca and Ford Motors have already started moving away from traditional budgeting as of 2003.( Neely, Bourne and Adams, 2003) Traditional budgets are characterised by compromises in that when requirements exceeds resources, budgets are modified accordingly as a compromise. They lack performance measures by overemphasizing on inputs totally ignoring outputs and are only mentioned in financial terms though there are justifications that it is convenient form of expression in order for departmental managers to understand. They are too inward looking without being sensitive to cross-functional nature of business processes. (Bellis-Jones,1992) . There is no denying the fact that budgeting function in many companies has been a mere ritual without any positive results. The recent KPMG surveys of 200 companies report says that only 1% of the responders has found their budgetary forecast 100% accurate. The survey reveals that resources are allocated based on incomplete information. (Controller’s Report, 2008) Budget is a bane of corporate life Jensen (2001) comes heavily on budgeting process terming it as corporate joke. Executives form top to bottom acting in unison compromise on many aspects affecting company revenues and profits under the pretext of conforming to budget estimates only to avail of their bonuses for meeting or exceeding targets. Targets are artificially met or exceeded resulting in heavy losses to the corporations. If the company already exceeds the target (already a compromised one), the sales executives move the end of the year sales to the next year so that performance for the next year is partially assured. In case of shortfall in sales, they do not hesitate to send goods to their dealers only to be returned later. And if there are sufficient orders but execution of which will be delayed resulting in shortfall in the targeted sales, they simply move the semi-finished goods to nearby locations of the large customers and process goods in those makeshift locations incurring extra costs. They indulge in all these practices only to avoid missing of their bonuses for target achievements. These are real life examples. Two actual examples are unavoidable. One international heavy-equipment manufacturing company’s managers in order to hit their quarterly revenue target shipped unfinished goods from their plant in England to a warehouse in Netherlands near their customer for final assembling. The company had to incur extra costs in the process for the sake of managers’ vested interests. Another example involves a beverage company. The vice president under-predicted sales revenue for a major holiday so that he could be sure of exceeding the target. However, the company, which relied on his prediction manufactured in lesser volumes, lost heavily without being able to meet the demand that far exceeded his prediction on the holiday. The result was that the company lost its core product to their competitors forever. Conclusion It would appear that budgeting as a tool of planning actually serves as a tool of undoing the planning in the hands of unscrupulous managers. Even otherwise, the inward looking and conformist nature of traditional budgeting has become a misfit in today’s world of shorter product life cycles and networking culture. Though the budgets are called the bane of corporate life for these reasons, the process itself cannot be altogether stopped. The bonus culture for target achievements must cease and alternative compensation known as curvilinear executive compensation should be adopted along with, zero base budgeting. The budgeting process must go on for even adapting to changing environments. As organisations have been adapting to changing environments, the budgeting is still a very popular management process as there has to be sense of direction which budgets alone can provide. References Bellis-Jones Robin 1992, “Budgeting for Improvement”, Total Quality Management, Emerald Backfiles 2007, April, P 103-105, Chapter 4 Budgetary control, FAO Corporate Document Repository, available < http://www.fao.org/docrep/W4343E/w4343e05.htm#TopOfPage.> accessed 5 December 2008 Controller’s Report 2008, “KPMG and Centage Surveys Identfy Remedies to Common Budgeting Pitfalls” Controller’s Report issue 08-04 April Available accessed 5 December 2008 Fanning John 2007, “Abolish Traditional Budgeting Process” Issues Measuring Business Excellence vol 2:1 Emerald Backfiles 2007 Jensen C.Michael 2001, “Corporate Budgeting is Broken-Let’s Fix It” Harvard Business Review, November LSE.CO.UK, Budgeting Definition, available < http://www.lse.co.uk/financeglossary.asp?searchTerm=budgeting&iArticleID=570&definition=budgeting> accessed December 2008 Neely Andy, Bourne Mike and Adams Chris 2003 “Better budgeting or beyond budgeting?” Measuring Business Excellence, Vol 7 no 3 p 22-28 Read More