Introduction
A budget is a short-term plan expressed in financial terms, or, a more broad term that extends into the future period. It is a plan of action covering one year, six months, or even a month. An annual budget is prepared yearly. The finance manager prepares them by making expenditure projections and revenue forecasts. A company revises historical data to arrive at these predictions. The company then makes adjustments to incorporate the aspect of inflation and other changing factors.
Budgetary control makes use of the budget standards set by the finance manager. Budgetary control involves a follow-up in the implementation stage of the budget. In case of any variances, there are corrective measures where necessary (Brotherton, 2008). However, the circumstances during the prediction stage are different from the circumstances during the implementation stage of the plan. Hence, the budget standards are critically ineffective or useless in pointing out any inefficiency in the production process. This is one of the limitations of the annual budgets, which push the modern business managers to adopt beyond budgeting approach of budgeting (Campbell, 1998).
Weaknesses of Annual Budgets
Traditional budgets are prepared to provide a plan of action for the company in achieving its long-term strategic goals and objectives. However, these budgets have many limitations that hinder the achievement of these objectives. Annual budgets are not flexible. They are fixed. This poses a major problem to today’s businesses (Armstrong and Kotler, 2011). The current business environment is very complex and uncertain. It is characterized by high levels of technological advancement and stiff competition. The organization that moves forward is flexible or is fast in adapting or responding to change (Weetman, 2007).
Annual budgets tend to be a predetermined plan along which all management decisions center (Heuser, 2010). The managers cannot exercise their discretion in determining what to invest in because the company’s resources are all occupied elsewhere. This limits the ability of the managers to respond quickly to the emerging threats and opportunities in the industry. This characteristic of annual budgets limits many companies from competing effectively with others in the same industry (Larson, 2004).
Secondly, the preparation of conventional budgets takes a lot of management time and uses a bundle of the company’s resources yet they add little value to the organization. A company’s resources are limited hence, there is a need to optimize its usage to gain more advantage and increase its profitability. The modern and traditional budgeting system requires a large sum of money in gathering information for the preparation of the annual budgets.
Yet due to the dynamism and complexity of the business environment, these budgets seize to be of any importance or they become obsolete and are of no use to the organization. Annual budgets merely show how much will be spent on sales and marketing, production overheard but it does not provide the most crucial information. For example, which is the best project to invest in, which is the best but most affordable method of production, how can we improve the quality of our products to give more value to our customers and increase profitability? This is the information the firm needs to have a competitive advantage and achieve its objectives the mere allocation of resources will not help (Tinnish, 2004).
Annual budgets are prepared at the present for use in the future. The environment in which this organization exists is crammed with many uncertainties therefore they cannot correctly predict what will emerge in the future. The business laws keep on changing, the level of technology advances, and the prices of commodities vary (Kouvelis et al. 2006). The organization that succeeds and survives these tough times is the one that can take advantage of the available opportunities and overcome its threats. The budget targets become outdated way before the budgeting process comes to an end this becomes a waste of the company’s resources. The company can invest the resources in a more profitable venture (Cleland and Gareis, 2006).
Convectional budgets do not foster innovativeness in the management but promote adherence to the budget. It does not encourage continuous improvement. That is managers and workers strive to achieve the set standards to ensure they do not have an unfavorable evaluation.
As a result, the quality of goods and services is compromised in the process. Compliance with the budget also results in wastage of resources since the management gives little attention to the need of developing better ways of production and utilization of resources. Operational managers will result in dysfunctional behaviors to ensure they earn their bonuses and that they do not get negative feedback from performance evaluation. This leads to little or no efficiency and effectiveness in the business operations (Harrison and Lock, 2004).
Furthermore, the annual budget pays little attention to the external aspect of the organization. That is the budgeting system of an organization has an internal focus. This is a weakness of the annual budget since the environment plays a major role in the success of the organization. The organization operates in an open system hence constantly interacts with the environment for example; the customers determine what to produce, how much, when, and where. Therefore for a firm to succeed it needs to look at both the external and internal aspects of the organization so that it can have a competitive advantage over its competitors (Jones, 2008).
Most managers use budgets as a tool of control and planning. The sole purpose for this is to ensure they reduce the cost of production, optimize the use of resources, and ensure customer satisfaction. However, in a fast-paced environment, the traditional budget system lacks in all respects and that is why most firms a removing towards an alternative budgeting approach (Randall, 1999).
Traditional Budgeting and Benchmarking
Benchmarking is a tool used in the improvement of policy execution and processes of a given firm. It is a technique based on the comparison and the exchange of information between two different firms in the same industry. One of which is the best among its peers. Benchmarking can also be within the organization (Harrison and Lock, 2004). That is between different departments in the organization. The information mainly exchanged is on the processes, policies, and targets set by the firms. The firm aims at improving its firm in terms of quality of services, cost of providing those services, and speed. Benchmarking implements strategic change to increase the firm’s efficiency and effectiveness and gain an edge over its competitors (Brotherton, 2006).
Benchmarking is a participatory activity open to all members of the organization. It requires a large team for the implementation, therefore. Workers’ involvement in benchmarking creates a sense of ownership and the workers are motivated to work. This also promotes innovation among the employees hence they become open to change. However traditional budgeting processes kill this motivation among its employees, it uses a top-down approach whereby what the management dictates is what will be. Due to this, there is the creation of a negative attitude towards the management by the employees (Sullivan et al. 2003).
Benchmarking is a continuous process. There is a need to continuously revise the standards set to effectively respond to the uncertainties in the environment. To always, be ahead of its competitors the firm requires flexibility in the standards set to be able to manage change in today’s dynamic environment (Maskell and Baggaley, 2003).
The revised standards will be relevant in the control process since they reflect the current situation and not an ideal situation. A traditional budgeting process is a once-in-a-year event. The expenditure projections are done at the beginning of the year and they are a revision of last year’s expenses. This renders the budget targets irrelevant in the budgetary control process and therefore it hinders the firm’s ability to implement strategic change. Unlike the traditional budgeting process, benchmarking promotes continuous improvement in all aspects of the organization. Traditional budgeting encourages adherence to the budget rather than continuous improvement (Sharman, 2003).
The conventional budgeting process concentrates on the internal operations of the firm. This ignores the external aspect. Firms are not in a closed system hence they cannot afford to overlook the influence of the external environment on their operations. It is through this concept that the traditional budgeting process hinders the implementation of strategic change by the use of benchmarking. Benchmarked results are obtained after careful assessment of both the internal and external operations of the firm (Hamilton, 2004).
Benchmarking relates to the environment through the exchange of information with its competitors and other departments hence creating lasting mutual relationships. It promotes collaboration among the competitors and the departments creating a favorable environment for business (Elliot and Elliot, 2004).
Traditional Budgeting Process and Balance Scorecard
A balanced scorecard is a scheme of performance measurement. It is involved in strategic planning and aligning business performance to the visions and objectives of an organization. A system of performance measurement and evaluation considers not only the financial perspective of the firm but also three other unique perspectives. These include the customer perspective, the internal business processes and the learning and growth perspective (Kaplan and Cooper, 2009).
It also aims at determining a way of executing the strategic plan by use of the four perspectives. The mission statement is used in execution of the plan. The balance scorecard as the name suggests also aims at creating a balance between different aspects of the firm the short term and long-term objectives of the firm, the financial and non- financial measures and finally the internal and external performance perspective. The balance scorecard translates the strategic plan to a language that the lower level manager can easily understand and implement hence making the work of the low-level managers easy (Horngren, Sundem and Schatzberg, 2010).
Traditional budgeting processes hinder the balance scorecard from achieving its aims of implementation of strategic change. First, the convectional budgeting process concentrates on the short-term objectives of the firm that does not go in line with strategic planning which focuses on the long run (Hines, 2004). Without a long run ambition, the firm will be going round rather than moving forward (Nokes, 2000).
Secondly, traditional budgets focus on the financial aspect of the firm during planning and in performance evaluation. For a firm too succeed all the aspect of the organisation are equally important and need to be given attention. The firm should consider increasing the level of efficiency in its business processes; continue adding value to the customers and creating wealth for its shareholders besides increasing it profitability (Jones, 2008).
Traditional budgeting process encourages compliance to the budget rather promoting continuous progress. Annual budgets create boundaries between the different departments in the organisation by separating them. Balance scorecard aims at integrating the different aspects of the organisation to create a system of performance and measure. This is however not possible with the use of the traditional budgets hence limiting the strategic implementation of change (Friedlob et al. 1996).
Traditional Budgeting and the Activity-Based Models
Activity-based model is a model that incorporates both the financial and operational aspect of the company. Activity-based model involves determining the activities performed and establishing the relationship between those activities first. Understanding of the relationship enables the manager make decisions on the allocation of resources (Friedl et al. 2005). Activity based model uses a bottom- up approach.
That is the lower level managers determine what activities are need to be performed which is translated to determine the resource requirements (Brimson, 2010). The manager then translates this into cost to come up with the financial budget. Activity-based model ensures resources are put to their best use and that all activities undertaken are important. This reduces wastage of the company’s resources hence promoting efficiency in the business processes. The operational budget makes it easy for the low-level managers to comprehend the plan and implement it with ease hence saving on time (Carnal, 2007).
Activity based model provides an opportunity for the operational manager follow up during the production process and in case of any shortage in the resources provided necessary adjustments can be made. Activity-based models are flexible hence, they helps the operational manager cope with the changes in the business environment, which may affect the business activities negatively (Betzig, 2006).
Traditional budgeting process uses a top down approach. That is the top-level managers are responsible for preparation of the budget. The expenditure is a percentage of sales revenue for example cost will be 8% of the sales therefore if the sales forecast is say 200,000 the cost of overheads is set at 8% of that amount. As a result, the managers do not have an idea what the cost drivers are. Besides that in traditional budgeting, the process of resource allocation is a negotiation process between the different departments. This implies, that resources are not put to their best use and it is characterised by a lot of workload and wastage of resources (Seal, Garrison and Noreen, 2008).
Conventional budgets are criticised for being too complicated for the low-level managers and the workers to understand. This makes it hard to determine who is responsible for those activities that cut cross-different departments. This brings about conflict and wastage of time and resources. As result, this does not allow the application of activity based theories to increase efficiency and effectiveness (Millmore, 2007).
Conclusion
Budget standards are critically ineffective or useless in pointing out any inefficiency in the production process. This is one of the limitations of the annual budgets, which push the modern business managers to adopt beyond budgeting approach of budgeting. Traditional budget models are not quite essential or useful in the current business environment. This is because of its unpredictability. Every company is making budgets as per its needs.
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