Introduction
The shortfall of traditional budgeting processes is increasingly becoming the area of debate in business finance. One of the widely highlighted arguments is that traditional budgeting processes limit flexibility and an entity’s ability to respond to various changes. Further, traditional budgeting is criticized for consuming a lot of the management’s time. Irrespective of how detailed a traditional budget is prepared, it quickly becomes outdated and, as a consequence of less use. The presence of a predefined framework also limits innovations among managers regarding spending and savings. It follows that there is a need for a new budgetary system to overcome weaknesses of the traditional budgetary system. The traditional budgeting processes should be eradicated because the current business environment is not only competitive and complex, but also dynamic. The Beyond Budgeting (BB) model has been documented as an influential concept that will transform the contribution of management accounting in business performance and operation. This paper highlights the limits of traditional budgetary processes and the alternative budgetary system by first discussing the purpose of budgets and the relevance of traditional budgetary systems to the contemporary dynamic business environment. It also discusses alternative budgetary systems that may be adopted in the present dynamic business environment.
The Purpose of Budgets and the Relevance of Traditional Budgetary Systems to the Present Dynamic Environment
The Role of Budgets in the Context of Planning and Control
Despite the growing criticism regarding the limitations of the traditional budgeting systems, the research has demonstrated that budgeting has been on the vital management control mechanisms throughout time in both private and public entities. This observation is also complimented in publications within the business finance control literature. However, it does not rule out the viewpoint that criticism should not be considered when entities design and to adapt new budgeting practice. To address the criticisms appropriately, various design possibilities and purposes of budgeting must be disclosed and used as the foundation for evaluating how the limitations can be addressed.
Budgeting serves as a key pillar of most entity’s control mechanisms, because it is one of the rare techniques capable of consolidating organisational activities into a single comprehensible summary. Typically, organisational performance is defined or measured in terms of profitability. Central to this metric, revenue (output) and cost (inputs) are balanced to ensure that an entity is financially healthy. Budgeting is the process through which the plans of actions regarding performance are chosen, communicated, coordinated and evaluated in an entity. It follows that the process consists of both decision making and planning aspects alongside performance measurement and monitoring aspects. It is noticeable that budgeting plays a critical role in target or goal setting procedure as it pre-set the performance standard in the next financial year. Further, budgeting induces the possibility of organizing planning and decision-making process in an organisation. Decision point and time of executing actions can be separated using well-designed budgets. This is essential in strategic decisions, including product development, market development, and implementation of innovative technology. In that respect, the significance of budgeting is that strategic tasks and related resources can be planned and controlled for each budget period.
The Relevance of Traditional Budgetary Systems to the Present Dynamic Environment
Traditional budgets are financial statements or documents used by individuals or entities to plan future spending and savings, as well as to plan expenses and incomes. In agreement with Pietrzak, budgeting is one of the most valuable and successful techniques or tools used in managerial accounting. As of this writing, almost all entities relied largely on budgetary systems or budgets to meet their strategic goals. In addition, budgets reap high rewards if they are properly implemented. Companies have been using traditional budgetary processes to estimate whether they can operate within their projected expenses and incomes. Most traditional entities use top-down budgeting process in which senior managers outline the overall figures, while lower and middle managers plan accordingly. It follows that a budget is a key pillar of the management control process in an organisation and is traditionally viewed as an accounting tool used by organisations for implementing strategies.
Horngren et al. noted that the purpose of a budget in the modern business arena is to direct managerial efforts and achieve organisational goals through planning, measuring, coordination, and rewarding. In other words, a budget serves as a financial plan designed to support specified targets. Further, the budgeting process entails setting strategic objectives and goals, as well as developing forecasts for cash flows, revenues, production, costs, and other key factors. Evidently, a budget is meant to serve three main purposes: communicate financial expectations; coordinate an entity’s financial activities; and motivate managers to act in the entity’s interest. To achieve the main purposes and objectives, Raghunandan and Raghunandan-Mohammed noted that both the behavioural and technical aspects of the budgeting process must be taken into account. The consideration of these aspects is important to achieve objectives and goals. The technical element of the budgeting process constitutes the mathematical computations of the projected expenses and costs. On the other hand, the behavioural element of the budgeting process covers the ability of people within the entity to achieve the technical component of a budget. The social and behavioural aspects of the budgeting process are integral part of the whole process, thus should not be overlooked.
Traditional Budgeting Approaches
There are numerous approaches to the traditional budgeting, because there are not predefined regulations outlining how and the type of budgeting approach should be applied or used within an entity. Further, there are other factors that influence budgeting that must be considered, including organisational structure, organizational culture, the management style, the complexity and nature of an entity’s internal operations, and the management philosophy. According to Hannien, the budgeting process is a back-and-forth interaction between the top and lower management. In line with this assertion, there are traditional approaches of developing budgets: imposed or top-down approach; participative or bottom-up approach; and negotiated budget. Out of the three approaches, top-down budget emerges as the most popular approach to budgeting. In this approach, the top management makes overall decisions regarding finances, whereas the middle and lower management ensures that a budget is executed accordingly. This approach needs experienced managers because inexperience ones can make bad decisions which might cause budgetary slack.
In contrast to the top-down approach, the bottom-up approach allows the lower management to make departmental budgets, which are integrated in the corporate budget. Bottom-up budgets increase motivation because of ownership. Additionally, these budgets tend to be detailed because employees and supervisors most familiar with teams, and departments prepare a budget. One of the disadvantages of the bottom-up approach is that senior management team may resent loss of control. Another con of bottom up approach is that budget preparation is time consuming because of disputes and further consultations. The negotiated approach is gaining popularity in the current dynamic business environment, because it adopts both participative and imposed styles of budgeting. As of consequence, a negotiated budget creates a business environment where everyone is responsible for the resultant budget. Additionally, the active participation of employees and managers in the budgeting process is vital because commitment is essential to the success of the process. While the top-down approach assumes autocratic style of leadership, the bottom-up budgeting approach assumes the democratic leadership style. In simple words, the approach is employed when budgeting depends on organisational culture and management or leadership style.
The most popular traditional budgeting approach involves the use of the previous financial year’s budgetary figures adjusted and aligned to the management’s goals and assumptions. Incremental budgets start with the figures from the previous financial budget and add or subtract a specific incremental amount to cover any changes. One of the advantages of incremental budgeting approach is that it is quick and easy. Additionally, this approach is suitable for organisations whose internal operations are relatively stable, and historic financial figures are acceptable. In stable businesses, costs rarely change significantly, and cost control is effective. However, unlike the past, the current business environment is very dynamic calling for budgeting methods that can address significant changes in costs. One of the disadvantages of incremental budgets is that they are built on previous inefficiencies and problems creating a continuous error in business finances. Further, uneconomic activities may be carried on. For instance, a manufacturing firm may continue to design and component in-house instead of exploiting cheap outsourcing options. Incremental budgets are also disadvantageous in the sense that managers may deliberately overspend the allocated financial resources to get more the next financial year.
Criticisms and Disadvantages of Traditional Budgeting Systems in the Present Dynamic Business World
The traditional budgeting systems are criticized for being time consuming and unresponsive to the dynamic business environment. Bartram noted that even the most efficient and leanest companies take over two months organizing their budgets. This is wasteful of time for an entity to spend on the process that arguably does not add tangible result to the business. Additionally, the traditional systems are obstacle to innovation because they are deeply rooted in old organisational cultures which restrict firms and the management team to reshape into modern entities. Previously, entities were smaller and employees’ relationships were anchored on trust. Staff acted on the best interest of their entity. As of this writing, companies have expanded in terms of location, capital and employee base. For this reason, trust among employees has been broken down. Initially, traditional budget would be used as a control mechanism to combat such trust issues. However, as it stands, the control aspect of traditional budgeting is more of a restriction to progress for modern and forward thinking entities. Further, traditional budgeting lacks value creation and strategic focus because the main focus is cost reduction. The bureaucratic nature of traditional budgeting limits flexibility, which eventually impacts on the entity’s creativity and innovation instincts. Employees may be demotivated if the controls created by traditional budgeting systems are not responded too well. To address the criticism and limitations of traditional budgeting systems, there is a need for alternative budgeting methods and solutions designed to adapt the new and ever changing environmental conditions, growing competition, market developments, customer orientation and technical progress. The section that follows discusses new trends in budgeting and alternatives to budgeting.
Alternative Budgetary Systems
Despite the popularity and widespread application of traditional budgeting systems, researchers and practitioners argue that it does not satisfy the needs of present day manager, because it has lost relevance with the modern day business environment. Due to the ever growing criticisms, alternatives to budgetary system are increasingly gaining popularity. These alternatives share the rationale that traditional budgeting systems are not perfect and should be fixed. This section analyses four key alternatives: Zero-Based Budgeting (ZBB), Rolling Budgets and Forecast, Activity Based Budgeting and Beyond Budgeting.
Zero-Based Budgeting (ZBB)
ZBB requires every cost element to be justified as if the activities included in a budget were being handled for the first point in time. Without their approval, the budget allocation is zero. ZBB is suitable for a business environment or activities where spending is discretionary, including advertising, R&D, and training. Before the resources are allocated to various packages, the packages are evaluated and prioritized through cost-benefit analysis. The analysis is conducted after specified activities are defined in decision package. Typically, decision packages state the revenues and costs expected from the specified activity. As the key documents in this method, decision packages help senior management to decide whether to approve or disapprove a specific activity. Decision packages can either be mutually exclusive or incremental. In the former, the packages contain various methods of achieving the same objectives, whereas in the latter an activity is broken down into different levels. The base package defines the minimum cost and effort needed for the activity, whereas the other packages define the incremental benefits and costs when summed to the base package.
The central advantage of ZBB results in improved staff engagement at all levels, because more information and directed effort are required to prepare a zero-based budget. ZBB is also effective in the fast moving environment, because it adapts to in the rapid business environment. The approach is effective in the sense that it calls for resources. Through zero-based budgeting, obsolete and uneconomical operations can be identified and discontinued, thereby increasing performance or profitability. Furthermore, ZBB enhances understanding and knowledge of cost behaviour patterns. One of the cons of ZBB is that it emphasizes short-term benefits at the cost of long-term goals. The fact that the approach is involving implies that the budgeting process may be tedious to an extent that the budgeting team may be unable to respond to unforeseen threats and opportunities. ZBB also requires high experience and management skills which may be lacking in new entities. Further, the senior management team may also be demotivated if they focus much of their time on budgeting. Working on the same thing for a long time may reduce the staff’s morale if the business environment is not motivating. Lastly, ranking decision packages can be challenging, especially where the benefits are qualitative in nature.
Rolling Budgets and Forecasts
Rolling stone budgets are those in which a budget, typically annual budgets are updated continuously by introducing another accounting period when the previous accounting period has ended. The added period may be a month or quarter (three months). This approach is suitable for business segments that need tight control. It is also suitable in scenarios where accurate projections cannot be made, especially in a dynamic business environment.
One of the advantages of rolling budgets is that planning and control are based on more accurate budget than the incremental budget. This budgeting approach also lessens the element of uncertainty because they focus on short-term where the level of uncertainty is relatively lower. Rolling budgets and forecasts also forces the management team to reassess organisational budgets frequently and to prepare budgets that are updated. Additionally, there are always long term projects which need budget that normally covers 12 months. Similarly to any other budgeting alternative, rolling budgets and forecasts are costly and time consuming, particularly more than incremental budgets. In the same light, rolling budgets are marked by issues of version control because the budgetary amounts change continuously. As managers focus on the numbers that should be achieved, distraction can crop up limiting the success of projects. Further, employees may be demotivated in the event that they feel that most of their valuable time is largely spent in budgeting rather than real tasks.
Activity-Based Budgeting (ABB)
As the name suggests, ABB relies on cost drivers and is linked to activity based costing. That is to say, the method is based on activity framework and utilizes cost driver data is setting a budget and variance feedback process. ABB emphasizes the creation of a budget based in business activities rather than business units. This approach is designed to address the fact that financial orientation in traditional budgeting and the related high-level process are problematic because the understanding of operational managers is limited. Additionally, the top-down approach is disconnected from business activities. In contrast to traditional budgeting, ABB focuses on the external issues linked to business activities rather than the internal issues.
One of the advantages of ABB is that it recognized that it is business activities that drive budgetary costs. It follows that if the budgeting team can control the drivers or causes of costs, then the entity can better understand and manage costs. The method also gives attention to overhead activities which can form a large proportion of the overall operating costs. Activity-based budgeting can also provide valuable information in a total quality management environment, by correlating the cost of an activity and the level of the provided services. Despite these advantages, ABB requires a significant amount of effort and time to establish major activities and the related costs. In the same context, it may be difficult to determine specific individual responsibilities for budgetary activities.
Beyond Budgeting (BB)
Beyond budgeting (BB) approach is more of a leadership philosophy which calls for a fundamental transformation in the management model emphasizing a decentralized approach to management. The approach is suitable for entities undergoing radical transformation, for example, a manufacturing entity using business process re-engineering where conventional budgets are difficult to achieve. BB is also suitable for entities using TQM and as well as an industry marked by rapid transformation in both internal and external business environment.
One of the benefits of BB model is that it creates a working environment based on competitive success. Additionally, BB motivates managers and employees by defining clear responsibilities. By making rewards team-based, BB eliminates some individualistic behavioural issues. In the same line, the BB model creates customer-oriented teams. Given that power is devolved to operational managers, the reaction time is quick because of their proximity to action and decision points. Lastly, the beyond budgeting model creates an effective information system which delivers open and fast information across the organisation.
Conclusion
Budgeting is a key management activity meant to support the management team in strategy planning, implementation and control of activities. From the traditional budgeting processes marked by estimation of future expenditure and incomes, such budgets are evolved to the contemporary techniques: activity-based budgeting, zero-based budgeting and beyond budgeting. These alternative budgeting methods are continuing to gain popularity because the promise solutions to the limitation associated with the traditional budgeting. Despite the fact that traditional budgeting is turning out to be unsuitable for the current dynamic business environment, it is still popular among entities and is still here to stay for quite some time. All entities set objectives and targets, but the organisational culture and management style remains as the key determinant of the budgeting approach employed within each organisation. Additionally, an entity may find it challenging to abandon the traditional budgetary processes, especially if they are deeply entrenched its business culture. However, deducing from the discussion above, traditional budgeting processes require revitalizing and refreshing to synchronize with the business and economic transformations noted by entities. Observably, most entities are not yet prepped for these changes, but it is evident that the model has the potential to reinvigorate the contribution of management accounting in business performance and operations. As much as numerous advantages are attached to beyond budgeting method, the approach is still in its early development strategies. For this reason, the concept requires further studies, development and real-world implementation before a tangible breakthrough in managerial accounting and dynamic business environment can be achieved.
