Budgetary Process Essay Example for Free

Budgetary Process Essay â€Å"Identify and describe the key features that a budgetary process should achieve to achieve managerial goal congruent behaviour. However if budgets are over emphasised myopic behaviour may be observed where a manager (or groups of managers) takes action(s) that improve budgetary performance in the short term but may cause long term harm to the organisation† Discuss. A budget is a short term, often one year, business plan, usually expressed in financial terms (Atrill, Mclaney, 2011, p.314). There are three broad functions of budgeting, these are: quantification of plans, help in financial planning, and monitoring and controlling scarce resources through performance measurements. Throughout this essay I shall be discussing these three areas, breaking them down into seven more specific features of budgeting. Furthermore I shall discuss how myopic behaviour can cause long term harm to an organisation. Goal congruence means developing and maintaining the various activities within the enterprise in proper relationship to each other (Welsch, Hilton, gordan, 1988 p.50). From a managerial point of view this is better explained by making sure they are aware of the different goals set by multiply departments within the organisation; as well as making sure their own goals are in line with the organisations overall plans. There are seven key features that a budgetary process should achieve in order to achieve managerial goal congruent behaviour. The first key feature is authorization, this makes managers accountable for their actions/spending and helps prevent fraud in an organisation (Atrill, McLaney, 2011). For an organisation it is important to make the right choice between a centralised control of the budget, where the organisations overall aspirations are at the heart of any decision making, or to delegate the responsibility to subordinates who will have a better understanding of their local environment. Usually a mixture of centralised and delegated control is chosen, giving some responsibility to subordinates to maintain motivated (Berry, Broadbent, Otley, 2005 p.108). Goal congruence is best achieved by using authorization in the budgetary process to keep Managers / Subordinates clear on what is expected of them from a financial point of view. The next four functions come into effect when planning a budget. Forecasting is critical in preparing an organisation for what is to come in the future, â€Å"looking ahead must be better than moving forward with eyes closed† (Garrett, 2010). It involves calculating many variables in order to predict future economic conditions as well as how governments and competitors will behave. On top of this, the company needs to forecast how the relationship between price and demand will change. Planning links in closely with forecasting as both use secondary data to help organisations determine what to do next. Drury (2004) states that managers are encouraged to plan whilst preparing the budget so that they can consider what changes may occur and how they can respond. An organisation needs to plan out how they are going to treat upcoming circumstances, for example seasonal changes, trends in the market and the likely hood of the company incurring growth or decline. A combination of forecasting and planning enables managers to remain goal congruent as they are aware of what is expected from them and what is expected to happen to the market or organisation in the future. This allows them to have a better understanding of how they are going to achieve their goals and helps keep them focused and in line with the organisation. Berry, Broadbent, Otley, (2005) states the budgetary process provides, in different ways, a focus for forecasting and planning, whilst serving as a channel for communication and coordination. Communication is a critical part of the budgetary process as it is vitally important that each area of the organisation is given a budget that is relevant to the overall goals of the organisation as well as to their specific needs. It is extremely difficult to keep every area of the business content with the budgetary targets and goals set. Individual areas in a business will be competing with each other when relating to funding, resources etc. Goal congruence is achieved through communication by making sure communication is efficient between the different hierarchical levels and between each department. Most organisations form a budgetary committee which includes the senior management that are responsible for designing the strategy; they also receive the initial budgets from each functional man ager (Weetman, 2010, p.319). This will enable swift and clear transparent communication when negotiating the budget, resulting in the best possible budget for each area of the business, whilst achieving the organisations overall aspirations. The final feature of a budget that comes into effect during the planning stage is control / coordination. I have touched upon coordination in the budget process whilst talking about communication as there cannot be effective control/coordination without effective communication and vice versa. Control is critical in planning budgets, as it is important to make sure each area of the business is accountable for its actions, as well as being able to link the budget/targets for each area together to compensate for possible weaknesses in the organisation. Such weaknesses arise when one area of the organisation is relying on another area that cannot commit to what is needed (Weetman, 2010, p.325). Having coordinated budgets allows superiors in the organisation to realise where there are weaknesses early on and counteract the negative effect. An example of this would be out sourcing if the work load for one area of the business is more than it can handle. Budgetary control is often implement ed through cost centres or profit centres. Profit centres allow centralised responsible for revenue, expenses and profit. Whereas a cost centre enables responsibility for mainly costs (expenses) (Welsch, Hilton and gordan, 1988 p.597). These again support goal congruence as the business as a whole is able to see how each specific sections of the organisation is financially performing and whether or not they are helping to achieve the company’s aspirations. Motivation and evaluation are features of budgets that come into effect once the budgets are active. Motivation in budgeting can make or break how goal congruent managers are as motivation in budgeting is an extremely tricky procedure. It has been proven that budgetary targets can indeed improve staff motivation. However too soft a target will make it too easy for staff to achieve and therefore staff performance may fall, whereas setting targets that are deemed unachievable are also likely to decrease performance. Geert (1968) reached the conclusion that provided the budget does not exceed the highest target acceptable to an individual; the results will increase in line with increasing difficulty. A budget allows organisation to set targets and goals that are then compared with actual performance and evaluated. When using budgets (that have been used for motivational purposes) for evaluation, managers need to be careful not to look on small deviations to harshly. A motivational budget is harder to achieve as it is there to improve performance and efficiency in the organisation (Drury, 2004, p.595). Managers should remember that the budget is financially based and evaluating areas such as innovation, corporate social responsibility, staff moral and customer satisfaction are also important to the organisation when evaluating good performance. â€Å"In the context of dynamic demand analysis, habit formation is defined to be â€Å"myopic† when in each period the individual takes into account his consumption history but does not recognise the impact of his present consumption decisions on his future tastes,† (Pashardes 1986).Myopic behaviour is where individuals, organisations or managers focus solely on the short term. In an accounting context this can be extremely detrimental to an organisation’s long term goals, as managers are more focused on achieving their short term budgetary plans than looking at the company’s overall targets. A myopic mind can bring many problems to an organisation’s none financial goals. If managers are too focused on ach ieving there budgetary targets it can stifle the creativity and risk taking culture of the organisation (CIMA, ICAEW, 2004). This intern can have dramatic long term effects on an organisation’s creativity and entrepreneurial ability, as it is critical for them to move forward and develop as an organisation. A prime example of this can be seen with the demise of Woolworths, â€Å"history might have been different had woolworths not clung to its time-served ‘pic and mix’ business model† (Boje, Burnes and Hassard, 2012, p.332). In the retail industry it should be critical for managers to remain focused on keeping their store modern. It is proven that modernised stores can set higher prices, leading to larger profits, due to a higher net value added (Hemashree, 2008). Clearly Woolworth lack of enthusiasm towards modernising their stores and being too focused on cutting costs lead to a negative operating environment, hindering their chance of survival. A myopic approach to budgetary goals leads to a concentration on cost reduction and not value creation for managers. For any retailer like Woolworths, managers know that staff take up a huge amount of the companies costs. In the short term it becomes increasingly tempting for managers to enforce staff redundancies to help achieve those targets set by superiors (Berry, Broadbent, Otley, 2005). The actions of cost cutting by retail managers including Woolworths, for example reducing staff during seasonal change (e.g. after Christmas), would cause long term costs to the organisation. Instead of paying high costs due to seasonal staff redundancies and staff training, organisations could reduce staff hours during low points in trading then increase staff hours in line with increasing sales. As well as hindering the organisations ability to think of new ideas, the budgetary process can also have an effect on future development that is already in the pipeline. New projects are often put on hold by organisations which become more worried about meeting financial targets, than trying to expand the company and launch into new markets or create new products. IBM’s budgetary process became so long during the 1970’s that it took 18 months to complete their ‘annual’ planning cycle (Hope, Fraser, 2003, p.7). IBM’s management were affected by another budg etary related issue; becoming excessively inward focused to the point where they were unaware of competitor’s behaviour. Due to their high planning cost this lead them to be unable to, and lacking the agility and ability, to counteract (CIMA, ICAEW, 2004). Whilst competitors like Apple were becoming innovated and pushing through their new ideas involving personal computers, IBM were too busy focused on how they, as market leaders, were going to launch the next big thing. IBM misread the personal computer revolution and was unable to react to lower cost advanced computers created by competitors (Hope, Fraser, 2003). â€Å"Keeping an eye on the potential risks and changes in the operating environment is essential – as one delegate noted, budgeting may provide you with a map but if you drive with your eyes closed, you will crash anyway,† (CIMA, ICAEW, 2004). There are many methods or remedies that IBM and Woolworths could off used to prevent the budgetary problems associated with myopic behaviour. Beyond-budgeting is a modernised version of the traditional budgeting process that allows botto m up empowerment. This seems to be the best way for organisations to adjust to the fast changing world of the information age (Hope and Fraser, 2003). IBM were affected by being inward focused and unaware of competitors actions. If IBM had been aware of the new beyond-budgeting process they would have been setting their goals in relation to beating their competitors and not the budget (principle 7) (de Waal, 2005). This would of kept them market focused and enabled them to react faster to their competitors actions instead of misreading the market. Driver based planning and budgeting would of, again benefited IBM by helping to shorten their ‘annual’ budgetary process. Incorporating operational drivers would have meant IBM could reforecast on request and would have been agile enough to adapt to uncertain trading conditions (Barrett, 2005). This process as well as enforcing beyond-budgeting principles could off shortened the planning process involving three thousand people that IBM had in place. Woolworth main problem, like many organisations suffering from managerial myopic behaviour, was a lack of innovation. They became too focused with cost cutting practices, trying to achieving budgetary goals. â€Å"Everybody has a sandpit to play in. my sandpit financially is my control plan, If I stay within it, I’m free to play† (Marginson, Ogden, 2005). Keeping innovated and flexible is critical to achieve the organisations long term goals as well as meet short term budgetary targets. In conclusion, traditional budgets are seen as being incapable of meeting the demands of the competitive environment and are criticized for impeding efficient resource allocation and encouraging dysfunctional behaviour such as myopic decisions (deWaal, Hermskens-Janssen, Van de Ven, 2011). I have demonstated how individual beyond budgeting principles can add to traditional budgeting to support organisations, using examples of IBM and Woolworths to demonstrate. De Waal (2005) states that research shows the more beyond-budgeting principles an organisation implements, the better it performs. A combination of budgeting and beyond-budgeting principles allows managers to balance the inherent rigidity of their budgets with the more organic processes of innovation. (Marginson, Ogden, 2005). Using the key principles of beyond budgeting enables managers to focus on achieving long term goals, in line with the organisation’s overall objectives, as well as helping to speed up and modernise the traditional budgetary process. It is however important to remember that the features of a traditional budget are extremely important to most organisations. â€Å"Budgeting provides an overall framework of control without which it would be impossible to manage,† (CIMA, ICAEW, 2004). References Atrill, P., Mclaney, E., 2011. Accouting and Finance for non specialists. 7th ed. Essex: Pearson Education Limited. Barrett, R., 2005. Budgeting and Reforcasting, Financial Management. Berry, A. J., Broadbent, J., Otley, D., 2005. Management Control. 2nd ed. Hampshire: Palgrave Macmillan. Boje, D., Burnes, B., Hassard, J., 2012. The Routledge Companion to Organisational Change. Oxon: Routledge. CIMA., ICAEW., 2004. Better Budgeting. London: Silverdart Ltd. de Waal, A., 2005. Insights from Practice is your Organisation ready for Beyond-Budgeting?, Measuring Business Excellence. Q Emerald Group Publishing Limited, 9 (2) (November) pp. 56-67. de Waal, A., Hermkens-Janssen. M., Van de Ven, A., 2011. The Evolution Adoption Framework. Emerald Group Publishing Limited. Drury, C., 2004. Management and Cost Accounting. 6th ed. London: Thomas Learning. Garrett, K., 2010. Budgeting. ACCA. Geert, H., Hofstede., 1968. The Game of Budget Control. London: Tavistock Publication. Hemashree, A., 2008. A Study on Working of Modern and Traditional Retail Outlets. Dharwad: University of agricultural sciences. Hope, J., Fraser, R., 2003. Beyond Budgeting. United States: Harvard Business School Publishing Corporation. Marginson, D., Ogden, S., 2005. Budgeting and Innovation, Financial Management. Pashardes, P., 1986. Myopic and Forward Looking Behaviour in a Dynamic Demand System, International Economic Review. Wiley, 27 (2) (June), pp.387-397. Weetman, P., 2010. Management Accounting .2nd ed. Essex: Pearson Education Limited. Welsch, G. A., Hilton, R. W., & Gordan, P. N., 1988. Budgeting – Profit, Planning and Control. 5th ed. New Jersey: Prentice Hall. Budgetary Process. (2017, Feb 04).