The Perceived Limitations Of Budgets

Published Date: 02 Nov 2017

This article examine the discussion about the budget has been the subject of widely unfavourable criticism, the fundamental of which seems to be that the budgeting being incompetent to achieve the requirements of the competitive modern environment in recent years. In other word, there are criticisms and debates over the value of budgeting. One of the eye catching statement "the budget is a tool of repression" by Bob Lutz, has sparks the interest of other practitioners response to this criticism resulted in more than just discussion. Some say it is well alive, some claims it is outdated and suggest for completely abandonment of budgeting as a whole, others say it should be improved adopt new developments and changing conditions into consideration. In this paper, after critically evaluating the BBRT and some academic scholars’ views on this issue, it will then move on to evaluate the study of some example case for the idea that organizations might abandon all forms of traditional budgeting and operate successfully. Further, it will consider alternative approaches to overcome the limitations of traditional budgeting practices. In the end of the article, a conclusion will be drawn as whether budgeting is still practical and valuable to the organizations currently.

How do the criticisms of budgeting made by Beyond Budgeting Round Table (BBRT) differ from those generally acknowledged by academics today?

The case against traditional budgeting has been debated by Hope and Fraser (2003b) as part of the Beyond Budgeting Roundtable (BBRT). They argue that budgeting systems often result in dysfunctional behaviour and consume large amounts of management time. Additionally, budgets often slow down organizations from being flexible and responsive to deal with unpredictable environments change facing modern organizations, and they are lack of alignment between budgets and the corporate strategy. They also addressed that budgets are not adequate to allocate resources efficiently, thus they are not sufficient in maintaining managerial control. Therefore these significant shortcomings lead to uncoordinated with competitive requirements.

The criticisms from BBRT have attracted the attention of scholars, practitioners and academics into the discussion. Dugdale and Lyne (2006) agreeing with the argument from BBRT, emphasize that most the financial managers in their study strongly agree that budgets were problematic in the way that budgets are too time consuming and managers might be constrained by budgets and delay necessary actions. However, they state that the critiques identifies above are not sufficient reasons to abandon budgeting but improvements should be required. According to a research by Neely et al. (2003), 80% of the organizations agree that the budgeting planning and process does not perform appropriately and it does not add value to the organization. They found that budgeting creation uses 20% of management time, even the most efficient companies take 79 days to arrange their budgets, whereas 210 days were spent in the worst practice companies. This is a considerable of time for an organization to spend on budgeting that arguably adds no value to the business.

In contrast, Horngren et al., (2008) assert that the result of a survey has shown over 92% of the 150 companies in North America highlighted that most managers still agree budgeting to be one of the most widely used and highest rated cost management tools for cost reduction and control. He maintains that the advocates of budgeting claim that the process of budgeting forces manager to become a better administrator and encourages planning in the fore-front of managers’ mind. In the same view, in a round table discussions organized by CIMA and ICAEW in 2004 on "The traditional role of budgeting in organization", it is stated that budgeting and the accompanying process are indispensable and some maintain that 99% of European companies have no intention to abandon it (CIMA, 2004). Nevertheless, Hope and Fraser (2001) claimed that budgeting are preventing organizations from competing effectively in globalized, deregulated markets. They maintained that this requires more effective strategic management and the replacement of the command and control structure of most organizations with the distribution of more authority to the front line.

On the other hand, Libby and Lindsay (2007) express that the problems are arising from how budgets are implemented and used within organization, if used appropriately they can be a very effective tool. Moreover, a survey of US organisations revealed that more than 50% of senior managers believed organizations could not manage without budgets despite the associated time and costs, budgets were adding value to an organization. Ekholm and Wallin (2010) agree with Libby and Lindsay, saying traditional budgeting is a strong framework to plan and measure a company’s operations if they are properly used. They claim that traditional budgeting is not dead yet, therefore it can be suggested that those inadequacies could be down to the implementation and not the tool itself.

To what extent does the type of organisation, its culture and environment affect how successfully a budget might operate?

The above critique against budgeting is most commonly applicable for large organizations in a rapidly changing environment and employing over 1,000 people.

Daum and Hope (2003) emphasize the growth of organisations causes the insignificance of traditional budgeting methods. The development of international organizations has caused a failure in trust between workforces, while formerly organizations were smaller and staff relationships were built on trust. Thus, budgets were used as systems of control, however it has affects organizations significantly.

Hope and Fraser (1997) found that the Svenska Handelsbanken was the large national Swedish bank that provided the example case for the idea that organizations could abandon all forms of traditional budgeting and operate successfully. They reported that a cultural change from budgets and targets to improvement has enabled costs to be driven down. They state that Svenska Handelsbanken utilised a radically decentralised organization structure to enable each branch to run as an independent profit centre and developed a performance and rewards culture based on competitive success at every level. These competitions build strong pressure to employees to perform at high levels of expectation as leaders run a governance structure based on strong principles and boundaries. Branches are allowed to adopt any action they consider are required to improve performance, for instance, they can access and adjust operational resources including staff levels. Additionally, managers are permitted to deal with customer needs since there are no product targets to achieve. It has strengthening controls throughout the bank as everyone views the same information simultaneously.

On the other hand, dissatisfaction with its traditional budgeting process also was the starting point for cultural change at Rhodia, a large specialty chemicals company. It is a large and complex global organization that has developed a clear methodology for replacing the traditional planning and budgeting process. The problem of their budgeting was the old planning and budgeting process started took more than six months to complete which was slowing down the response times. Moreover, business management teams barely spent time on strategy and thus lack of any clear link with strategy to manage the process. The only concern was at the factory level, where a number of managers were used to working with predetermined plans and schedules that defined their work programs for the year ahead. Therefore Rhodia replaced the budgeting process with two performance strategic view and continually reviews two to five years ahead with an annual review. Whereas the other takes an operational view and looks five to eight quarters ahead with a quarterly review. Managers focus on medium term strategy instead of short term fixed targets, and on high level key performance indicators rather than detailed numbers. These enable managers respond more effectively to developing threats and opportunities.

Another example case has been discussed is Borealis, a leading European petrochemical manufacturer had been dissatisfaction with their budgeting practices. It abandoned budgeting in 1995 and subject to rapid and unpredictable change. They set an upper limit on costs and constituted an effective floor or base amount for expenditures. Managers most likely to spend whatever amounts the budget authorized because unexpended sums at year-end could prompt funding cuts for the following year, therefore regularly leads to wasted resources. Moreover, top management did not comprehend budgeting as an ongoing process that continuously takes an enterprise’s changing environment into consideration. Instead, it viewed budgeting as an annual one-shot exercise, which committed sizable resources for a considerable period of time.

How should organisations today overcome the perceived limitations of budgets?

Practitioners in Europe and the U.S have suggested two alternative approaches to overcome the limitations of traditional budgeting practices. Both suggestions originated from the Consortium for Advanced Manufacturing-International (CAM-I). Better Budgeting approach suggests improving the budgeting process and generally focuses on the budgeting planning problems. Alternatively, Beyond Budgeting approach suggests abandoning the budget and focuses on the budgeting performance evaluation problems.

The US based CAM-I Activity-Based Budgeting (ABB) group suggests to improve budgeting through budgetary planning, the budget language and budgetary control more to the operations in the organization. This group practice the analytical approach advocated in Activity-Based Costing methods to elaborate an operational plan before drawing up a financial budget. The operational plan is based on decisions about number of end-products, required activities, resource consumption rates and total production capacity. In order to consider how it adds into the organization’s financial planning and required financial outcomes, a plan in operational terms is then translated into financial terms.

An alternative option for organizations to utilise formal budgeting system is Better Budgeting, which entails five techniques to overcome some of the limitations of traditional methods (Neely et al, 2003). Activity Based Budgeting involves planning using value adding activities, following a similar concept to ABC and ABM. Zero Base budgeting assist managers to justify their budgets annually to attempt and prevent dysfunctional behaviour and budget games. Thirdly, a Value Based technique encourages a focus on creating shareholder wealth and linkages in relation to corporate strategy. Profit methods consider both short and long term projections whilst ensuring sufficient cash is generated. Finally, Rolling Budgets create frequent budgets to provide more accurate forecasts.

The European-based CAM-I Beyond Budgeting Round Table (BBRT) group proposed a completely different approach and recommends to abandon budgeting and to introduce instead a system of decentralized decision making, in the hands of empowered local managers, while replacing budget-based performance evaluation by relative performance contracts with hindsight. This approach attempts to provide an alternative for budgeting, which enables management to make planning and control more strategy-related. However, CIMA (2007) believe that having no budget creates various problems. Organizations will have no framework for planning, managing and controlling its activities, and thus these could be failed without detailed plans of its current position and future goals. A radical culture change can cause employees feeling dissatisfy and the decentralized structure may be impractical for some organisations.

Conclusion

To conclude, BBRT’s view is that traditional budgeting is redundant and not applicable for the current environment or it can be essentially abolish shareholder value within an organization. They advocate that Beyond Budgeting is a more effective system which overcomes the limitations of traditional budgeting methods. However, it is unlikely that it will be fully adopted Beyond Budgeting as numbers of techniques are particularly practical within the modern environment. After evaluating the discussions and opinions of several academics, they believe it might be difficult for management completely abandon budgeting, as it is embedded it business culture. They rely on Better Budgeting techniques could be practiced in order to improve the failing traditional budgeting but not completely abandoned it. Some criticisers seem to be forcefully pursuing a movement in contrast to the traditional budgeting. This may be understandable seeing that some of the active critics are management practitioner attempts to persuade organizations to adapt their management models. The finding of this article is the Beyond Budgeting show example cases are helpful in discovering alternative ways of managing modern companies, but they do not convincingly provide an alternative management concept, capable of replacing the budgeting function. There are numbers of critiques in management accounting articles encourage organizations to replace budgets with some techniques and approaches.

(2000 words)