Benefits and problems concerning traditional approach to budgeting

Benefits and problems concerning traditional mean of attack to computeingIn enunciate to advise devil distinct ancestryes nigh the benefits and problems associated with traditional approach to ciphering and cipherary correspond, i obtain coll electroshock therapyed and compiled the information regarding work outing and divided it into assorted disperses so that the reader may easily belowstand .1.INTRODUCTION A calculate is a plan and figureling tool for an oraganisation.This tool female genitalia work effectively plainly when it is utilize with due c ar.It is non still the a cost monitoring mechanism but also an full part of an organisations readiness and control activities.It aims at achieving organisational objectives and motivating the personnel pertain.For the victory of budgetary musical arrangement gathering the essential informationand choosing an appropriate budgetary brass etc. ar necessary.The beliefl budegting clay is unity that fires g oal congruence(i.e. a situation where the own(prenominal) goals of the employees match the oraganisational goals).Ensuring the greater participation of the supervisory aim in the instruction help foot ensure goal congruence.Budgets may be of different fictional characters to tear downt the different practices followed by different organisations.An organisation development a conventional clayof budgeting may som generation lead to switch over to an different to suit its requirements.Changing a budegtary system is not a simple task.An oraganisation has to face certain(prenominal) difficultiesin the form of resistance to change by the personnel of the organisation,changes c each for in the existing support systems etc., inorder to change its budgetary system.The Success of a budget is also largely waitant on the level of accuracy in estimating the revenues and be for the budget stop. in that respect argon several statistical techniques which may test useful in forecast ing the figures to be in unifiedd in budgets.2. traditional BUDGETING2.1. IntroductionFirst of all we begin this topic with the simple interpretation of budget.In short budget tail be delimit as quantifiable economic plan make with regard to time. Therefore, for some amour to be characterised as a budget it essentialiness comprise the quantities of economic resources to be allocated and utilize, it has to be verbalised in economic i.e. m nonp atomic number 18iltary toll, it has to be a plan not a hope or a forecast but an definitive intention, and it must be made indoors a certain period of time (Harper, 1995, p. 318). Only a plan that has much(prenominal) characteristics back be called a budget.However, if a budget is looked upon in its wider context, it advise be define as a circumspection tool that puts executives in control of the m integritytary health of their comp some(prenominal). It is an objective measure of the financial construction of comp anys oper ation and a tool that forces prudence to be accountable in a coordinate and objective elan. Budgets as counselling tools by themselves atomic number 18 neither technical nor bad. How effrs administer budgets is the key to their value. When administered wisely, budgets facilitate homework and resource allocation and serve up 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 numerical exercise, but in reality it is much, much more(prenominal) than than numbers on spreadsheets, which is what following(a) text lead definitely show.The purpose of budgeting is that it gives anxiety an idea of how well a company is beseeminging their income goals, whether or not expenses ar in line with predicted levels, and how well controls argon working. Properly utilize, budgeting provide and should plus benefits, reduce unnecessary spending, and distinctly define how quick steps can be taken to expand markets (Thomsett, 1988, p. 5). In order to achieve this, com guardianship needs to build a budgeting system, the major objectives of which argon to (Viscione, 1984, p. 42)Set pleasurable targets for revenues and expenses.Increase the likelihood that targets will be r for each oneed.Provide time and fortune to formulate and evaluate options should obstacles arise.Since budgeting as a process is genuinely complex, it comes as no surprise that budgets are essay to fulfil numerous functions such(prenominal) as (Harper, 1995, p. 321, and Churchill, 1984, p. 162)Planning a budget establishes a plan of satisfy that enables management to know in stir the gets and timing of the production factors required to meet desired level of sales. delayling a budget can be used to help an organization reach its objectives by ensuring that each of the respective(prenominal) steps are taken as plan.Coordinating a budget is where al l 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 on the button they must be doing and what other(a) parts of the organization will be doing. A budget is designed to give managers a clear understanding of the companys financial goals, from expected cost savings to targeted revenues.Instructing a budget is very much as much an executive order as an organisational plan since it lays raft what must be done. It may, thitherfore, be regarded by subordinates as a management instruction.Authorising if a budget is a management instruction so conversely it is an authorisation 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 activate t hem to try and attain their budgeted targets.Performance measuring by providing a bench mark against which factual functioning can be measured, a budget clear plays a crucial role in the grave task of writ of execution measurement.Decision-making it should never be assumed that a budget is set in concrete and when changing course 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 entire organization.Delegating budgets proxy 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 virtually bare when the process is introduced in a company. operate managers learn not only the technical aspects of budgeting but also how the company functions and how their business units in teract with others. go against management of subordinates a budget enhances the skills of operating managers not only by educating them roughly how the company functions, but also by giving them the hazard to manage their subordinates in a more professional manner.The requirements that all these functions overturn upon a budget make it difficult for one system to meet them all. It is precisely because these requirements differ, that role conflicts in budgeting system arise. These need to be fittingly dealt with so that dysfunctional behaviour like budget padding or other damaging budget games for the company do not appear. Since there are triple 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 readiness role, it should be found on a rea heelic assessment of the companys operating capabilities and on managements judgment about what is most possible to hap pen in the future. Yet this kind of budget runs the risk of setting targets so low that motivation is adversely bear on since to motivate determinely, budget objectives should be set higher than those for planning and be difficult yet getatable. On the other hand, these difficult yet attainable objectives lead to an overly optimistic budget and run the risk of move 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 action can be judged. Managers are also likely to be more committed to achieving this kind of objective since they know that the carrying out standards by which they are evaluated are not constantly changing. On the other hand, managers motivation can be impaired by rigid finishing of a fixed standard philosophy which doesnt consider the impacts of uncontrollable or unforeseeable events and doesnt allow for their removal from budget standards.Plann ing 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 milieual variables from the budget used for evaluation purposes. Yet, because they are separated in time, the conflict amid these requirements is considered a minor one since it can be considerably minify if appropriate adjustments are done at the end of the budget period.As can be seen in the previous paragraph, functions that normal budgets want to bounce back are very wide. It comes whence as no surprise that those budgets are being used today in practice for many purposes. Bunce, Fraser and Woodcocks (1995) mint showed that general uses of budgets can be divided into financial and operational type of uses. Figure 2 clearly indicates that, of the miscellaneous uses of budgeting for management, the most classical are those financially oriented like the use of budgets for financial f orecast, cost control, funds blend management, and large(p) expenditure supervision. The operational management uses of budgeting have been slight plebeian but the interviewed companies have concluded that, in todays business environment, they are of growing importance. The need to improve act is intensifying to the point that it is no farseeinger enough just to control costs, butThat company must also pay assist to things like strategy, communication, and employee evaluation. These are purposes for which budgets have not been used so much in the past.As say in the opening definition, budgets are plans set for a certain period of time, such as a month, quarter, and year and so on. This time period is then customaryly 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 re importantder of the year. Of course, actual time periods for which budgets are made depend mostl y 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 in the raws program budget stems from the French word bougette and the Latin word bulga which was a trounce bag or a large-sized purse which travellers in medieval times hung on the saddle of their horse. The treasurers bougette was the predecessor to the small leather case from which finance ministries even today in countries like Great Britain and Holland present their one-year financial plan for the state. So after being used to show 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 cash bags.The use of budgets as financi al planning and control tools for business opening moves is historically a rather young phenomenon. In the US, early budgetary principles in companies were mostly derived from the budget techniques in government. The other source of budgetary principles for business in the US was the Scientific Management Movement, which in the years amongst 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 story to the total enterprise. However, it was not until the depression years after 1930 that budget control in US companies started to be employ on a large-scale.Budgets with their focussing 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 open up Henri Fayol (1841-1925). There was, however, little application in practice. A nother practical input signal 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 into a confederation of independently run small businesses. Nevertheless(prenominal), the main inducement for the development of budgets and their slaying 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., southward 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 spread out into new products and markets. This was to help them to reduce the complexity of managing multiple strategies (Hope, Fraser, 1997, p. 20). The enormous vicissitude in the product markets served by these vertica lly integrated corporations required new systems and measures to coordinate dispersed and decentralized activities. In this kind of environment, budgets and ROI measure justifiedly 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 performance within management history or in the words 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 competitive 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 this assessment.2.3. Budgeting ProcessThe process of budgeting for the most part 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 agreeable (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 described 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 budget ing/accounting terms and consolidated into one overall company budget.The budget is reviewed, modified as necessary, and approved.The final budget is then used throughout the year to control and measure the organization.The necessary dependence of individual budgets on one some other requires that budgets be vigilant in a graded 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 a few(prenominal) 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 domiciliated a list of eight budget choices that managers have to be concerned with when setti ng 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 budget 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 ground 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 cleverness and emphasize coordination and control aspects of budgets, while smaller innovative firms should concentrate more on the planning aspects of their budget s.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, examine 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 leadership 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 consist 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 contr ol 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 balance sheet and income statement.In figure 4, all major budgets that can be used in a typical company and how they are linked and interconnected 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 differentiated 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 currency 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 tending(p) 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 big as the block of money is not overspent before the end of the year, the budget mud 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-run choices of actions. Before continuing, it must 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 growing 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 translate plans into action and genuine 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 displacement reaction into more specific shorter-range plans. Once these short-term plans are quantified, they become budgets. That is wherefore in many instances short-term planning and budgetary planning are used as synonyms. However, as figure 6 will show, inter-group communication 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).Apart from the purposes of setting desired objectives and goals and linking them with strategic long-range and tactical short plans, the fundamental objective of management planning wi thin 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 concepts 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 smooth 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 budg et 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 control is to provide a formal 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 means that plans and the resulting information on the performance of the plans are expressed in terms of human responsibilities because i t 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 lead responsibility only over those figures that they have control. However, in practice, controllability1 is difficult to mote 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, alongside 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 authorit y 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 stainless 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 identical 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 be fore 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). However, on the same page, it is verbalize 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 if properly 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 c ommunication 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 nuclear fusion reaction of interest and to increase motivation.Managements time can be saved and attention directed to areas of greatest concern by the exception principle which is at the heart of budgetary control.Performance at all levels is systematically account 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 c ompared 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 integration of budgets makes it possible to better manage cash and working capital and makes stock and buying policies more realistic. nada 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 qualitative 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 commemorate their cent ury 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 weaknesses 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 focussed and are often contradictory.Budgets concentrate on cost reduction and not value creation.Budgets constrain responsiveness and flexibility, and are often a barricade to change.Budgets add little value since they tend to be bureaucratic and disapprove creative thinking.Business processBudgets are time consuming and dear(p) to put together.Budgets are developed and updated too infrequently, usually annually.Budge ts 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 people 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 to a higher place listed benefits and disadvantages of budgeting system have been present since the first d