MANAGEMENT ACCOUNTING
Management Accounting
Introduction
Setting the annual budget has been one of the mandatory activities in organizations at both tactical and operational levels. The annual budget outlines the projected revenues and costs for the firm in the coming year or the finite time period. Such budget is set to clarify the organizational direction to pursue by identifying the target revenues and variable costs associated with the business operations. It served as a successful budgeting process for several years, but today’s highly dynamic and continuously changing business landscape has made this system obsolete. In the 21st century, the annual budgeting which is also referred to as the traditional budgeting is being accused of being incapable of successfully meeting the demands and needs of today’s competitive environment. In this information age, a massive number of firms have abandoned the annual budgeting process as it is considered not to deliver desired outcomes. The study aims to critically discuss the associated challenges in a business environment and access its relevance to the 21st century business landscape. The discussion also aims to reveal possible solutions to mitigate the potential difficulties associated with the implementation of annual budgeting
Over the span of the last ten years, the annual budgeting has been the center of adverse criticism as this budgeting technique is no longer seen to meet the demands of the competitive environment in the highly challenging information age. Management consultants have presented a number of theories and models and persuaded the organizations to make changes in their managerial models (Ekholm & Wallin, 2000).
There could be seen a significant change in the accounting methods in the 21st century. Many researchers believe that the annual budgeting method has become outdated in relevance to the changes taking place in the business environment. The competitive trends have been transformed and imposing extensive pressures on the firms and their operating and accounting procedures. The technological advancements have caught an extended speed whereas the power of suppliers, customers, and macro environmental forces also significantly influence the firms. The annual budgeting model prepares a budget for 12 month period, which outlines the income and expenditure that are needed to be received and paid in the coming one year. But it ignores the flexibility and applicability in accordance with the continuously changing business landscapes (Gillanders, 2005).
Challenges in business environment and annual budgeting
Key Challenges
One of the core challenges observed is that the annual budget suffers from many ailments. It is considered to be inefficient, ineffective and incomprehensible based on what critical analysis about this technique. It was a use full managerial accounting model during the industrial age when it focused on the command, hierarchy, and control within the organization. But today it fails to meet the demands and challenges of information age which is also referred to as the third wave. The information age involves challenges of competitive climate, innovation, high demands for extensive quality of services, speed, and overall quality, meeting the customer needs and wants and knowledge sharing. These factors are considered crucial to consider as these are likely to alter the entire performance of the business operations, management, and accounting systems.
The annual budgeting process is based on a rigid planning process with incremental thinking which is highly time consuming and lacks the ability to reflect necessary changes in the organization and its processes. It is also discouraged by the organizations following new approaches because it produces inadequate variance reports which fail to answer how and why in the processes. It reflects a strategic rigidity as when a affirm develops an annual budget the senior management determines what will be the four of the organizations for the periods of next year and the entire next year the firm will execute the effort to achieve those predetermined targets. It lacks the flexibility and compliance with the changes (Robinson, 2009). A real life example can be quoted as Fortune 500 Company uses a traditional static annual budget where it sets the monthly sales goals of each and every product. The drawback is that if the company lacks the ability to meet the sales targets, the product manager is likely to push the projected sales for the final quarter of the year. The outlook for the entire year remains the same even when sales targets are not met (Myers, 2001).
The annual budget only incorporates the financial outcomes as it is concerned with the allocation of cash to specific business activities. It does not deal with the subjective issues, including quality of product or services provided to the customers. In the information age, these non financial issues also need to be considered in the budget.
In today’s information age the consideration of shareholder value as well as the stakeholder value is highly needed. But the annual budget ignores the key drivers of value for the company’s shareholders as it imposes extensive attention on the short term financial numbers and strategies. This promotes a culture of risk aversion which may lead to the false sense of security and characterized as being unable to highlight the changes in the competitive environment (Berg & Karlsson, 2014).
The annual budget as reflected by the name types the firm with a 12-month commitment which is very risky as is it is based on the uncertain forecasts. In such circumstances, a budget can become a restriction for the organization in becoming competitive and efficiently responding to the environmental and business dynamics and customer demands. As innovation and technology is changing within a year, it is hard for the firms to use an annual budget as any strategic move taken by the competitors can generate a need to alter the strategic and financial moves by the firm.
Solutions
As annual budgeting is criticized for being a functionally-based budget, which focuses on hierarchy, command and control system, the information age can successfully implement a process-based budgeting system. The process-based budgeting model aims at developing the power to the front-end people in order to empower them in coping up with emerging competitive trends. A delegation of power to the front line people can keep the firm updated as these people can quickly respond to the changes and challenges imposed by the change in innovation, technology, speed, demand for quality and competitive trends. It provided the basis for developing a system which focuses on strategic performance, value adding processes and knowledge management system which can strengthen the firm’s competitive and strategic position (Merchant, 2013).
Rolling forecast method also provides a solution for the shareholder problems associated with annual budgeting. It is expected to live up to the promise of increasing the shareholder value in the highly competitive information age. Another important solution is that firms can use the rolling budgeting technique along the annual budgeting (Lynn & Madison, 2004).
Conclusion
The study analyzed the criticism that annual budgeting process in incapable of meeting the demands of the competitive environment and today’s information age. By critically evaluating the challenges and their relevance to the annual budgeting it can be clearly seen that it was suitable for industrial age when there was a trend to focus command, hierarchy, and control within the organization. However, it lacks the ability to respond to today’s competitive moves, speed, efficiency, quality and demand for effective customer services. It incorporates a rigid planning process, and more emphasis is imposed on the financial outcomes. Moreover, it does not promise the desired level of shareholder value and restricts the organization to stay commitment with the 12-month budget predetermined at the start of the term. To overcome these difficulties the organizations can use process-based budgeting with a flexible forecast system. To mitigate the adverse impact of the annual budgeting, the rolling forecast system is considered to be the most suitable budgeting method for 21st century firms as it is likely to meet the shareholder value, and provides a forecast on the monthly and quarterly basis.
Bibliography
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Ekholm, B. G., & Wallin, J. (2000). Is the Annual Budget Really Dead? European Accounting Review, 9(4), pp. 519-539.
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Merchant, K. A. (2013). Companies Get Budgets All Wrong. Available at: http://www.wsj.com/articles/SB10001424127887323873904578571810482331202
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Zeller, T. L., & Metzger, L. M. (2013). Good Bye Traditional Budgeting, Hello Rolling Forecast: Has The Time Come? American Journal Of Business Education, 6(3), pp. 299-310.
