Introduction
Traditional budget making has been playing an important role in the business environment since the dawn of 1900 and is considered to be one of the major evaluators and key drivers of managerial performance in every organisation. It also plays a critical part in the designing as well as implementation elements that affect the organisation wide planning and control.
Traditional budget making is the most powerful tool which has been in use for management control as it plays an essential role in the organisation’s corporate politics. It can also increase the authority and power of the senior or top management and limits the autonomy of lower-level managers to a certain extent.
Besides offering numerous advantages, traditional budget making presents some of the critical disadvantages also. In recent years, it is observed that criticism concerning traditional budget making has kept increased for many obvious reasons. The basis of such criticisms is that formulating and design of traditional budgeting seems to be one of the remains of the past in the rapidly changing business environment full of intense global competition.
Making of traditional budgeting prevents any sort of reaction to a given change in the marketplace. It is also observed that this kind of budget making fails to keep up with the changing requirements and environment of today’s business world due to which traditional budgeting is not useful and seems obsolete for financial management of every business. In order to remove such a heavy criticism on traditional budgets, practitioners as well as researchers in the field of accounting finance have developed more realistic and systematic alternatives to traditional budgeting which address the needs of investors and the modern business environment in a far better manner. Such alternative techniques are known with the names of better or beyond budgeting, a rolling forecast and activity based budgeting are some of the alternatives designed in recent years.
Keeping the above mentioned concepts in mind, this research paper is written to analyse if the traditional budgets should eradicated from use or not. This paper also makes a discussion on the reasons for which organisations and many finance experts are shifting from traditional budgets to other alternatives like beyond budgeting and a rolling forecasts etc.
Discussion
Under this section the problems of the traditional budget are elaborated in detail which is followed by a discussion on the realistic alternative to traditional budgetary process. Traditional budget making is considered to be the most important, useful and successful technique or tool in the field of managerial accounting . These days, almost every business organisation is dependent heavily on budgets and traditional budget models to achieve corporate goals so as to harvest lucrative financial returns if traditional budgets are well implemented and understood (Moolchand, Mohammed, & Ramgulam, 2012, pp. 110).
The problems of traditional budgeting identified by many financial managers sum up to three distinct categories: timeliness, processes followed while designing and the involvement of related human resources. It has been cited that the issue related to time required to make traditional budgets is considered to be the most problematic drawback. This is so because traditional budgeting undergoes as well as requires a heavy and long design process. It usually takes more than four to five months to formulate a realistic traditional budget consuming up to thirty percent of a financial manager’s time which can not only be expensive costly but may have many serious consequences and may hurt the bottom line of financial statements as well. Considering the utilization of needed resources, traditional budget making only adds a little value to the business entity and creates no value for stakeholders. Moreover, human resource related aspect is also problematic because traditional budget making creates dysfunctional behaviour, cause difficulties for the communication as well as cooperation across departments within the business entity when used to measure performance and setting personal targets. Traditional budgeting also creates numerous confusions and difficulties when corporate objectives and strategic goals are set too high or too low because this budget never responds quickly to the rapidly changing business environment once it is locked (Réka, Ştefan, & Daniel, 2014, p. 579).
In recent years, the BBRT (Beyond Budgeting Round Table) spent many days and hours to examine the actual performance management techniques as well as business models of various big entities while producing an enormous number of business cases. It concluded that traditional budget making is one of the furthermost barriers to environmental and social change in the field of business management.
The average organisation spends approximately four months and twenty to thirty percent of financial manager’s and senior executive’s time on the traditional budget making. Some businesses normally take around six to ten months in presenting a real picture of a traditional budget. For example, in the year 2003, the Hackett Group investigated into its business processes and found in its research that an average billion-dollar business utilizes the services of as many as 27,500 persons while compiling the annual traditional budget .
Opponents of traditional budget making hold the opinion that, in today’s dynamic environment where buyer’s marketplaces have become global and every economy is obliged to keep itself updated with regards to information as well as about knowledge, traditional budgets have continued to prove to be a danger for achievement of lasting corporate success. The director of BBRT North America, Steve Player, presents the idea that traditional budgets prevent flexible and quick adaptation to the changing dynamics of the global marketplace and so, the true potential of financial and human resources is never realized. This technique of formulating budget often promotes deception, mistrust and endangers the organisational transparency of financial records which is demanded by the investor base.
Specific Issues Associated with Traditional Budgets
In theory, there are, specifically, three primary issues with the design and formulation of traditional budgets which are identified as follows:
- It consumes a lot of time; formulation costs are too high and require the utilization of enormous quantity or amount corporate resources. For some businesses, the traditional budget making process takes as long as 06 to 08 months. Many organisations, operating on a financial accounting or fiscal year, start the budget making process in summers which do not even end till the month of December or even after the next traditional budget formulation period has started. Most of traditional budgets are designed in a very comprehensive manner requiring the input as well as back and forth communication of people across departments throughout the company. Such an exhausting activity only adds more to the extra utilization of corporate resources consumed by traditional budgeting. Furthermore, in many instances, internal or corporate politics also come into play which becomes more important than the potential/existing customer base with employees and managers self-occupied as a result .
- Traditional budget is often fixed dye to its inflexibility and is more vulnerable to quickly become irrelevant. It starts top-down and then, the traditional budget becomes a comprehensive self-building process to achieve already established and fixed corporate goals/objectives set by the senior level management regardless of whether they are realistic or not. Once a traditional budget is locked, no more modifications could be made even if the business environment and its dynamics changes in a dramatic manner. The economy may respond to a change, marketplace conditions or industries may undergo change, something specific to an organisation may change. Regulatory environment may bring changes to the competitive field. New competition or entrants may emerge where innovative concepts, new partnerships, new inventions or other internal factors having financial consequence may be introduced. There are numerous things that undergo change and yet the traditionally designed budget only views at things as they were in the past when it was formulated which makes it obsolete in today’s business environment. A survey concerning the planning, budgeting and forecasting practices found that fifty five percent of respondents (organisations) revealed that the assumptions used for designing their budgets were different than actual results which made those budgets useless within the first two quarters of the year. It was noted that this trend continues to increase as volatility in the global market conditions increases due to the accelerating emergence of enormous number of businesses and entrepreneurship competing with one another.
- Most of the global companies tie employee and executive compensation as well as other financial benefits directly to their respective performance against the traditional budget. In such a case, the main objective for executive becomes “How can the performance expectations be minimized?” The easiest way to performing the control function is to negotiate an overly achievable traditional budget standard so that hitting the targeted objective could be reached easily. If any manager is responsible to manage a cost centre dependable for spending, such an employee is more likely to maximize the size of the budgetary spending as much as possible. This is so because it will allow the financial manager to utilize the most resources regardless of their relevance and vice versa will be the situation when the employee is deployed in revenue production centre.
When it comes to traditional budget making, accountants and financial managers should refrain from presenting the financial figures and allowing other experts analyse what meaning those numbers have. If accountants and financial managers do not respond quickly to any change, they will become more vulnerable to lose their relevance and, in the end, lose jobs .
Many experts in the finance field making traditional budgets argue that the process to design and simultaneously update such a traditional budget is either missing or broken. They oppose the formulation of traditional budgets accepting that smart financial managers perform some useless and irrelevant stuff which even fails to add value to the organisation and stakeholder value.
Because of these issues, traditional budget processes do not work and that businesses must adapt a model of continuous planning and rolling budgetary forecasts. Several large and successful companies, like Unilever and American Express, have already shifted from traditional budget making for the three major problems witnessed in a more dynamic and volatile business environment identified in previous sections of this paper. The major problem with traditional budgets is that they are actually based on certain assumptions about what an economy is going to do, about future competition, future actions customer, actions by the government, regulatory authorities and foreign currency fluctuations etc the vast majority of which are outside the control of the organisation (Amato, 2013).
When those assumptions mentioned in the previous paragraph turn out to be wrong, the corporate objectives and plans based on them go wrong, too. As a finance professional, managers would want to adhere rigidly to those plans and perform monthly variance analysis and explanations when the benchmark is not achieved. Since many of the financial storms and rapid changes are not completely known, the budgetary benchmark would have been widened due to which financial management becomes a problem, not the solution.
The Remedy to Traditional Budgeting - Rolling Forecasts
As it has been cited that the traditional budget has many flaws and disadvantages that add no value, many financial managers are confused as to what should be done to prepare realistic and quickly responding budgets. The rolling forecast seems to be more logical adaptation of the fixed budget and its forecast which largely addresses the problems with the traditional budget design and planning processes which have been raised above.
The rolling forecast is a first step towards adapting a realistic performance management system. To understand the dynamics of a rolling forecast in a better manner, consider an explorer who travels the ocean while pursuing the discovery of the New World. The traveller may have with him many charts and maps but what if the person is required to change the course due to rise of unplanned conditions like sickness, terrible weather and the occasional attack of pirate ship. In absence of any kind of tool that could help the traveller steer unplanned deviations from the actual plan and reorganize the journey, captain might end-up in Boston rather than Belize.
A rolling forecast could broadly be described as a realistic future projection that is based on previous performances and updated routinely for incorporating information and input which reflects changing competition, market dynamics, business conditions and industry. Instead of focusing on a fixed target, rolling forecast is a best current predictor of the business’s operational and financial performance over a given time period.
Such a time period may range from twelve to twenty-four months or some quarters ahead. A rolling forecast “rolls” due to the fact that as time keeps moving forward, the established forecast time horizon will also be extended which is not the case for a traditional budget ending at a fixed time horizon. Ideally, financial managers do not wish to look into the future that becomes too unpredictable and unrealistic, but they also refrain from keeping the time horizon shorter or they are unable to see the full influence of their business decisions.
Typically, a rolling forecast is updated on an ongoing basis instead of a quarter or semi-annual basis. This means that rolling forecasts require less time to update and are more accurate than a traditional budget forecasting model. Compared to traditional budgets, where financial managers start from scratch and are obliged to redefine the business model and organize the financial resources on a yearly basis, rolling forecasts involves minor changes as they are updated persistently on a shorter-term basis which saves a lot of time and use of extra capital.
Rolling forecasts attempt to explain the third issue which has already been outlined above where employee and executive compensation is directly linked to managerial performance against the proposed traditional budget which emphasizes outperforming the existing competition to achieve corporate objectives and posting lucrative results. For example, an organisation may employ key metrics of an industry to gauge managerial performance against the competitors in the related industry leading to reward of lucrative bonuses for company executives if they surpass the competition.
Responding to a Dynamic Change
European companies have pioneered the shift from the use of traditional budget approach to other alternatives mentioned in this section in earlier paragraphs. The business climate is different there which is generally influenced heavily by less regulated and an open market. In the United States, business managers have a short-term mentality leading to a too much focus on generation of quarterly earnings and the resulting influence on prices per share. This activity drives organisations towards using traditional budgets, which is closely monitored by Wall Street which leaves little room for financial flexibility.
Conclusion
After a careful analysis and examination of performance management systems, one may conclude that beyond budgeting are rolling forecasts are proposed in this research paper as influential ideas that have a potential to reinvigorate the contribution of management accounting in an organisations operation and performance management activity (Goode & Malik, 2011, pp. 210). It is also concluded in this study that the traditional budgeting system must be eradicated from use as the business environment has become so competitive and complex that traditional budget making in its true form seems obsolete and is no longer constructive for organisations if they are to achieve higher corporate success. As stated earlier, dissatisfaction with and criticism on traditional budgets continues to increase in the business world where a rolling forecast and beyond budgeting are suggested as realistic methods to reinvigorate the contribution of management accounting .
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