Benefits and problems concerning traditional approach to budgeting

Benefits and jobs concerning traditional approach to cypheringIn order to advise two different craftes al nearly the benefits and problems associated with traditional approach to calculateing and work prohibitedary harbor, i turn in collected and compiled the in traffic patternation regarding budgeting and divided it into different parts so that the reader may easily understand .1.INTRODUCTION A budget is a supply and keepling tool for an oraganisation.This tool tin bath work effectively save when it is employ with due cargon.It is non only the a cost monitoring apparatus unless as well as an integral part of an organisations planning and mesh activities.It aims at achieving organisational objectives and motivating the personnel concerned.For the success of budgetary organisation gathering the essential informationand choosing an sequester budgetary system etc. atomic number 18 necessary.The elevated budegting system is one that progresss goal congruence(i.e. a situation where the personal goals of the employees match the oraganisational goals).Ensuring the greater participation of the supervisory level in the management parade can ensure goal congruence.Budgets may be of different types to suit the different practices followed by different organisations.An organisation using a conventional systemof budgeting may som terms need to switch over to an some other to suit its requirements.Changing a budegtary system is not a simple task.An oraganisation has to face certain difficultiesin the form of resistance to change by the personnel of the organisation,changes required in the existing support systems etc., inorder to change its budgetary system.The Success of a budget is also for the most part dependant on the level of accuracy in estimating the revenues and costs for the budget menstruum.There argon several statistical techniques which may prove useful in prevision the figures to be incorporated in budgets.2. TRADITIONAL BUDGETING2. 1. IntroductionFirst of all in all(a) we begin this topic with the simple definition of budget.In short-change budget can be delimit as Quantitative economic plan made with regard to time. Therefore, for something to be characterised as a budget it must comprise the quantities of economic resources to be allocated and apply, it has to be expressed in economic i.e. monetary terms, it has to be a plan not a hope or a forecast but an authoritative intention, and it must be made within a certain period of time (Harper, 1995, p. 318). Only a plan that has such characteristics can be called a budget.However, if a budget is considered upon in its wider context, it can be defined as a management tool that puts executives in adjudge of the pecuniary health of their comp all. It is an objective measure of the pecuniary structure of companys operation and a tool that forces management to be accountable in a structured and objective way. Budgets as management tools by themselves are n either good nor bad. How managers administer budgets is the key to their value. When administered wisely, budgets facilitate planning and resource allocation and second to enumerate, itemize, dissect and examine all of the products and services that a company offers to customers (Seer, 2000, p. 187). In short and taken at its simplest level, a budget is a mathematical exercise, but in reality it is much(prenominal), much much than numbers on spreadsheets, which is what following text lead definitely show.The purpose of budgeting is that it gives management an idea of how well a company is meeting their income goals, whether or not expenses are in bankers bill with predicted levels, and how well controls are working. Properly used, budgeting can and should increase profits, reduce unnecessary spending, and intelligibly define how immediate step can be taken to expand markets (Thomsett, 1988, p. 5). In order to achieve this, management needs to build a budgeting system, the maj or objectives of which are to (Viscione, 1984, p. 42)Set unimpeachable targets for revenues and expenses.Increase the likelihood that targets will be reached.Provide time and opportunity to formulate and evaluate options should obstacles arise.Since budgeting as a offset is very complex, it comes as no surprise that budgets are trying to fulfil numerous functions such as (Harper, 1995, p. 321, and Churchill, 1984, p. 162)Planning a budget establishes a plan of action that enables management to retire in advance the bars and timing of the production factors required to meet desired level of sales.Controlling a budget can be used to help an plaque reach its objectives by ensuring that each of the individual steps are taken as planned.Coordinating a budget is where all the financial components of an organization Individual units, divisions, and departments are assembled into a coherent master picture that expresses the organizations overall operational objectives and strategic goals.Communicating by publishing the budget, management explicitly informs its subordinates as to what exactly they must be doing and what other parts of the organization will be doing. A budget is designed to give managers a clear mind of the companys financial goals, from expected cost savings to targeted revenues.Instructing a budget is often as much an executive order as an organisational plan since it lays bundle what must be done. It may, therefore, be regarded by subordinates as a management instruction.Authorising if a budget is a management instruction then conversely it is an mandate to take budgeted action.Motivating in that a budget sets a target for the different members of the organization so that it can act to motivate them to try and extend to their budgeted targets.Performance measuring by providing a benchmark against which actual execution of instrument can be measured, a budget clearly plays a crucial government agency in the important task of carry ing into action measurement.Decision-making it should never be assumed that a budget is set in concrete and when changing build a well-designed budget is a very useful tool in evaluating the consequences of a proposed alternative since the effect of any change can be traced throughout the total organization.Delegating budgets delegate responsibility to the managers who assume authority for a specified set of resources and activities. In this way budgets emphasise even more the existing organizational structure within the company.Educating the educating effect of a budget is perhaps most evident when the operate is introduced in a company. Operating managers learn not only the technical aspects of budgeting but also how the company functions and how their business units interact with others.Better management of subordinates a budget enhances the skills of operating managers not only by educating them about how the company functions, but also by giving them the opportunity to m anage their subordinates in a more professional manner.The requirements that all these functions impose upon a budget make it difficult for one system to meet them all. It is precisely because these requirements differ, that role meshs in budgeting system arise. These need to be subduely dealt with so that dysfunctional behaviour like budget padding or other damaging budget games for the company do not appear. Since there are three major roles for any budgeting system, at least three conflicts may arise (Barrett, Fraser, 1977, p. 141)Planning versus motivationFor a budget to be most effective in the planning role, it should be based on a realistic assessment of the companys operating capabilities and on managements judgment about what is most likely to happen in the future. Yet this physique of budget runs the risk of pose targets so low that motivation is adversely affected since to motivate flop, budget objectives should be set higher than those for planning and be difficul t yet attainable. On the other hand, these difficult yet attainable objectives lead to an overly optimistic budget and run the risk of falling short and under using company resources.Motivation versus evaluationThere is a widely held belief that budget objectives should be set as fixed standards against which achievement can be judged. Managers are also likely to be more committed to achieving this kind of objective since they know that the doing standards by which they are evaluated are not constantly changing. On the other hand, managers motivation can be impaired by rigid application of a fixed standard school of thought which doesnt consider the impacts of uncontrollable or unforeseeable events and doesnt allow for their removal from budget standards.Planning versus evaluationThe planning roles requirement of providing realistic assessment of future prospects can conflict with the need to eliminate the effects of uncontrollable or unforeseeable environmental variables from th e budget used for evaluation purposes. Yet, because they are separated in time, the conflict mingled with these requirements is considered a minor one since it can be considerably reduced if appropriate adjustments are done at the end of the budget period.As can be seen in the previous paragraph, functions that typical budgets want to cover are very wide. It comes then as no surprise that those budgets are existence used today in practice for more purposes. Bunce, Fraser and Woodcocks (1995) survey showed that general uses of budgets can be divided into financial and operational type of uses. Figure 2 clearly indicates that, of the various uses of budgeting for management, the most important are those financially oriented like the use of budgets for financial forecast, cost control, cash flow management, and capital economic consumption supervision. The operational management uses of budgeting have been less common but the interviewed companies have concluded that, in todays bus iness environment, they are of growing importance. The need to improve cognitive process is intensifying to the point that it is no longer enough just to control costs, butThat company must also pay attention to things like scheme, communication, and employee evaluation. These are purposes for which budgets have not been used so much in the previous(prenominal).As stated in the opening definition, budgets are plans set for a certain period of time, such as a month, quarter, and yr and so on. This time period is then usually broken into smaller sub periods. The most frequently used budgets are annual budgets that are subdivided by months for the first quarter and by quarters for the remainder of the year. Of course, actual time periods for which budgets are made depend by and large on their purpose and use, and it is solely the decision of individual companies as to what time periods will be utilized for their budgeting process.2.2. History of budgetsThe English word budget stems from the French word bougette and the Latin word bulga which was a leather bag or a large-sized purse which travellers in medieval times hung on the saddle of their horse. The treasurers bougette was the harbinger to the small leather case from which finance ministries even today in countries like Great Britain and Holland present their yearly financial plan for the state. So afterwards being used to describe the word wallet and then state finances, the meaning of the word budget in 19th century slowly shifted to the financial plan itself, initially only for governments and then later for private and legal entities (Hofstede, 1968, p. 19). It was only then that budgets started to be considered as financial plans and not just as money bags.The use of budgets as financial planning and control tools for business enterprises is historically a rather young phenomenon. In the US, early budgetary principles in companies were mostly derived from the budget techniques in government. The ot her source of budgetary principles for business in the US was the Scientific Management Movement, which in the years betwixt 1911 and 1935 conquered the US industry. Many historians agree that early budgeting systems can be seen as a logical extension of Taylors Scientific Management from the shop floor to the total enterprise. However, it was not until the depression years after 1930 that budget control in US companies started to be implemented on a large-scale.Budgets with their focus on cost control simply became a perfect management tool for that period of time (ibid., p. 20). In Europe the idea of using budgets for business was firstly formulated by the French organization pioneer Henri Fayol (1841-1925). There was, however, little application in practice. Another practical stimulus came from the ideas of the Czechentrepreneur Thomas Bata (1876-1925) who introduced the so-called departmental profit-and-loss-control as a tool for decentralizing his international shoe company in to a federation of independently run small businesses. Nevertheless, the main inducement for the discipline of budgets and their implementation in European companies came from across the Atlantic in the years following the Second World War (ibid., p. 21).Companies like Du Pont and General Motors in the U.S., south in Germany, and Saint Gobain and Elctricit de France in France, which pioneered the M-form (multidivisional) organizational structure in the 1920s, first started to use budgets to support their rapid growth as they expanded into current products and markets. This was to help them to reduce the complexity of managing multiple strategies (Hope, Fraser, 1997, p. 20). The enormous diversity in the product markets served by these vertically integrated corporations required new systems and measures to coordinate scatter and decentralized activities. In this kind of environment, budgets and ROI measure rightly played a key role in permitting central management to coordinate, motivate and evaluate the performance of their divisional managers, and perform a proper allocation of internal capital and resources (Johnson, Kaplan,1991, p. 11). However, it is was only in the 1960s that accountants started adding to budgetsother functions (like management performance evaluation and motivation) in addition to those functions for which they had originally been devised planning and control (Hope, Fraser,1999b, p. 50). In that period, budgets became the central and most important activity within management accounting or in the lyric of Horngren, Foster and Datar the most widely used accounting tool for planning and controlling organizations (2000, p. 178). This is exactly how budgets have remained to this day. The only thing that has changed in the meantime is the agonistical environment in which todays companies operate and which has provoked many discussions about budgets disadvantages and their alternatives, some of which will be presented in later parts of th is assessment.2.3. Budgeting ProcessThe process of budgeting chiefly involves an iterative cycle which moves between targets of desirable performance and estimates of feasible performance until there is, hopefully, convergence to a plan which is both feasible and acceptable (Emmanuel, Otley, Merchant,1990, p. 31). Alternatively, if we look beyond many details and iterations of the usual budgeting process we can see that there is a simple universally applicable budgeting process, the phases of which can be depict in the following manner (Finney, 1994, p. 16)Budget forms and instructions are distributed to all managers.The budget forms are filled out and submitted.The individual budgets are transformed into appropriate budgeting/accounting terms and consolidated into one overall company budget.The budget is go offed, modified as necessary, and approved.The final budget is then used throughout the year to control and measure the organization.The inevitable dependence of individual budgets on one another requires that budgets be prepared in a hierarchical manner. Figure 3 indicates a common hierarchical form of the budgeting process together with the necessary data flow between particular budgets and phases of their making. This picture shows that despite having only a few general phases, the budgeting process, due to its linearity and iteration loop, is in fact a very complex and time consuming process.Since it is so complex and important, the budgeting process requires lots of decision making on the particular choices that developers of budgets have at their disposal. Churchill (1984, p.151) has provided a list of eight budget choices that managers have to be concerned with when setting up the budgeting system. Thereby, these concerns vary according to whether the company intends to use its budgets primarily for planning or for control. These budget choices areWhether it is to be prepared from the bottom-up or top-down,How it is to be implemented,How the bud get process is linked to the strategic planning process,Whether it should be a rolling budget and how often it should be revised,Whether performance should be evaluated against the original budget or the one relating to the actual activity level of the organization,Whether compensation/bonuses should be based on budgeted performance,What budget evaluation criteria should be used, andWhat degree of stretch should be incorporated into the budget.In general, accounting theory suggests that large companies should be concerned more with operational efficiency and emphasize coordination and control aspects of budgets, while smaller in advance(p) firms should concentrate more on the planning aspects of their budgets.2.4. Types Of BudgetsA budget is not a unitary concept but varies from organization to organization. The basic concept of budgeting involves estimating future performance, comparing actual results with the estimate, and analyzing the differences between them. Factors that are relevant in determining the type or style of an organizations budget and its effects include the type of organization, the leaders style, personalities of people affected by the budget, the method of preparation, and the desired results of the budgeting process (Cherrington, Cherrington, 1973, p. 226).In general, budgets can be classified into two primary categories (Cohen, Robbins, Young,1994, p. 171)Operating budgetsOperating budgets lie down of plans for all those activities that make up the normal operations of the firm. The main components of the firms operating budget include sales, production, inventory, materials, labour, overheads and RD budgets.Financial budgetsFinancial budgets are used to control the financial aspects of the business. In effect, these budgets reveal the influence of the operating budgets on the firms financial position and earnings potential. They include a cash budget, capital expenditures budget and pro forma respite sheet and income statement.In fig ure 4, all major budgets that can be used in a typical company and how they are linked and unite within the larger system of the master budget can be seen. This confirms what has already been said about the budgeting process that individual budgets are dependent on one another which requires that they be prepared in a hierarchical manner.Except for the usual division of companies budgets into operational and financial, budgets can also be severalise based on expenditure authority. Using this approach, two major groups of budgets can be defined (Kemp, Dunbar, 2003, p. 3)Line-item budgetsThese are budgets where the name of each line is set, as is the amount of money that can be spent on each item. If one works within a line-item budget, one can not overspend a specific line item and then compensate this with savings on other line (or vice versa). The authority to move money from one line item to another must be granted at a higher level.Block budgetsThese are the opposites of line- item budgets. Here a block of money is given. The details of the budget are presented but, later on, if one wants to spend more money on one item and less on another, one is free to do so. As long as the block of money is not overspent before the end of the year, the budget remains under control.2.5. Budgets as planning toolsWelsch, Hilton, Gordon (1988, p. 73) have defined the budgeting process as a profit planning and control process and in that way not only have identified the two most important functions of budgets in organizations, but have also presented budgeting process in a wider context than it is usually depicted. Figure 5 clearly shows that the budgeting process is more than just a process of combining quantitative financial plans. It is a tool with which top management cascades strategy goals to operating levels. Budgets are ideal for this purpose since they are in essence the detailed quantification of targets for short-term choices of actions. Before continuing, it mu st be emphasised here that budgeting is not planning it is just the quantification of planning.Since the budget is fundamentally a plan, planning is the first important element of budgeting work. Planning is one of the elementary functions of management. It is the process of developing enterprise objectives and selecting a future course of action to accomplish them. It includes establishing enterprise objectives, developing premises about the environment in which they are to be accomplished, selecting a course of action for accomplishing the objectives, initiating activities necessary to learn plans into action and current replanning to correct deficiencies (Welsch, Hilton, Gordon, 1988, p. 3). It is a phase that involves the interpretation of the broader strategic policies derived during the formulation of strategy and their translation into more specific shorter-range plans. Once these short-term plans are quantified, they become budgets. That is why in many instances short-term planning and budgetary planning are used as synonyms. However, as figure 6 will show, connection between planning and budgeting is not isolated from influences of other elements that constitute corporate planning system and it is precisely the coherent functioning of the complete system that allows corporate planning to be implemented, period by period, through the budgetary process and its two elementary phases budgetary planning and budgetaryControl (Lucey, 1996, p. 104). away from the purposes of setting desired objectives and goals and linking them with strategic long-range and tactical short-range plans, the fundamental objective of management planning within budgeting system is to provide a feedforward process for operations and control. It is this feedforward process that renders the planning phase of the budgeting system vitally important since it allows control and corrections of plans before they are even implemented. The difference between feedback and feedforward conce pts is that feedback monitors past results to detect and correct disturbances to the plan, while feedforward reacts to immediate or forthcoming dangers by making adjustments to the system in advance in order to cope with the problem on time, i.e. feedback monitors, feedforward warns (Lucey,1996, p. 144). Since in any organizations it is unlikely that pure feedforward or pure feedback control could operate in isolation because feedback control is too slow, while feedforwardcontrol is too risky, these two concepts usually function within a single budgeting system as can be seen in figure 7.2.6. Budgets as control devices At the beginning of the period, the budget is a plan. At the end of the period, the budget is a control device to measure performance against expectations so that future performance may be improved. Control is achieved through continuous reporting of actual progress and expenditures relative to plans i.e. budgets (Shim, Siegel, 1994, p. 15). The aim of budgetary contr ol is to provide a white-tie basis for monitoring the progress of the organization as a whole and of its component parts towards achievement of the objectives specified in budgets (Lucey, 1996, p. 147). Budgetary control process usually functions in a closed loop. This loop, which is illustrated in figure 8, starts with the planning phase, then records actual transactions, and finally reports against the plan and generates management response.In accounting literature, budgeting is also known as responsibility accounting. This substance that plans and the resulting information on the performance of the plans are expressed in terms of human responsibilities because it is people, not reports that control operations. We can define responsibility accounting as a system of accounting in which costs and revenues are analysed in accordance with areas of personal responsibilities so that the performance of the budget holders can be monitored in financial terms (Lucey, 1996, p. 147). So the crucial thing for profit control is the division of authority and responsibility to managers. This means that managers should accept responsibility only over those figures that they have control. However, in practice, controllability1 is difficult to pinpoint for at least two reasons (Horngren, Foster, Datar, 2000, p. 195)Few costs are clearly under the sole influence of one manager.Over a long enough time span, all costs will come under somebodys control.For this reason, companies, on board traditional responsibility centres2, also usually set up budget centres. These can be defined as a part of an organization for which a given manager has responsibility and authority and to which profit control data can be assigned (Harper,1995, p. 320).For budgeting control purposes, a special type of budget is prepared called the flexible budget. In order to understand why only those budgets can be used for the accurate measurement of performance, firstly the difference between them and fixed budgets must be explained. The fixed budget is based on the level of output planned at the start of the budget period. On the other hand, the flexible budget is developed using budgeted revenues or cost amounts based on the level of output actually achieved in the budget period (Horngren, Foster, Datar, 2000, p. 220). For this reason, from a control viewpoint, the fixed budget is likely to be inappropriate (unless by pure chance the actual level of activity turns out to be the alike(p) as the planned level which is highly unlikely) and should not be used for control purposes. It is with respect to this sort of budget that the old saying the budget is out of date before the budget period even begins is often a correct one (Harper, 1995, p. 336).2.7. Benefits and problems associated with traditional budgetingIt is claimed that today as many as 99 percent of European and US companies are using budgets and have no intention of abandoning them (Better Budgeting A report, 2004, p. 2). H owever, on the same page, it is stated that as many as 60 percent of those companies claim that they are not completely satisfied with their current budgeting systems and are continuously trying to improve them (ibid., p. 3). From this evidence, it is obvious that budgets carry with them many benefits and problems.Here is a list of some of the benefits that traditional budgeting can bring into organization ifproperly implemented and administered (Lucey, 1996, p. 161)It is a major formal way by which the organizational objectives are translated into specific plans, tasks and objectives related to individual managers and supervisors.It is an important medium for communication of organizational plans and objectives and of the progress made towards meeting those objectives.The development of budgets helps achieve coordination between the various departments and functions of the organization.The involvement of all levels of management in setting budgets, the acceptance of defined targets , the two way flow of information and other features of a properly organized budgeting system all help to promote a coalition of interest and to increase motivation.Managements time can be saved and attention direct to areas of greatest concern by the exception principle which is at the heart of budgetary control.Performance at all levels is imperiousally reported and monitored thus aiding the control of current activities.The investigation of operations and procedures, which is part of budgetary planning and the subsequent monitoring of expenditure, may lead to reduced costs and greater efficiency.The regular systematic monitoring of results compared to the plan (i.e. the budget) provides information upon which current operations are adjusted to bring them into line with the previous plan or, adjustments are made to the plan itself where this becomes necessary.The integrating of budgets makes it possible to better manage cash and working capital and makes stock and buying policie s more realistic.Nobody has better summarized in one sentence all the advantages of traditional budgeting as did Umapathy in his major work on budgeting practices in U.S. industry from 1987.Umapathy stated There is no other managerial process that translates soft mission statements and corporate strategies into action plans, links the short-term with the long-term, brings together managers from different hierarchical levels and from different functional areas, and at the same time provides continuity by the sheer regularity of the process (Umapathy, 1987, p. xxii). It is exactly because of this that budgets will soon celebrate their century long existence.Since budgets encompass so many different functions and are used for so many things in organizations, it is obvious to expect them to have certain weaknesses. A group of authors at the Cranfield School of Management made an extensive review of budgeting literature. As part of their research, they identified 12 significant weakness es of traditional planning and budgeting practices. These factors fall into three principal categories and can be listed as follows (Neely, Bourne, Adams, 2003, p. 23)Competitive strategyBudgets are rarely strategically focused and are often contradictory.Budgets concentrate on cost reduction and not value creation.Budgets constrain responsiveness and flexibility, and are often a barrier to change.Budgets add little value since they tend to be bureaucratic and discourage creative thinking.Business processBudgets are time consuming and costly to put together.Budgets are developed and updated too infrequently, usually annually.Budgets are based on unsupported assumptions and guesswork.Budgets encourage gaming and dysfunctional behaviour. organizational capacityBudgets strengthen vertical command and control.Budgets do not reect the emerging network structures that organizations are adopting.Budgets reinforce departmental barriers rather than encourage knowledge sharing.Budgets make pe ople feel undervalued.Furthermore, one of the biggest problems with budgets is that they tend to promote an inward-looking, short-term culture that focuses on achieving a budget figure, rather than on implementing business strategy and creating shareholder value over the medium to long term. For all these reasons, it is believed that these weaknesses lead collectively towards business underperformance and should therefore be dealt with (ibid).The above listed benefits and disadvantages of budgeting system have been present since the first d