Research on Budgeting and Abandoning Budgeting

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Research on Budgeting and Abandoning Budgeting for Management Yang Liang

Yan Wang

Department of Humanities and Economic Management China University of Geosciences Beijing, PRC 100083 [email protected]

Department of accounting and finance Napier University Edinburgh UK Eh105lw

Abstract Budgeting, as a short-term plan in companies, have their strongpoint. However, some people say budgeting are barriers. This thesis analyzed the significations of budgeting and beyond budgeting. In the end, it gave the feasibilities of using beyond budgeting. Keywords: budgeting; beyond budgeting; feasibilities

1. Introduction Budgeting as a short-term plan in companies is benefit for management operates the organization. But there are some opposite opinions existing in the reality, especially in traditional budgeting. Some people think “budgeting are barriers to change in companies that wish to devolve responsibility and respond more quickly to competitive threats and opportunities”. So, in this paper, I will firstly analyze why this view point existing now, and then discuss the solutions for budgeting problems, whether adopting better budgeting or abandoning budgeting. Finally, I will give my opinion about this problem.

2. Signification of budgeting In companies, there are always two types of plan one is long-term plan, another one is short-term plan. In 1989, Sizer defined long-term planning as a systematic and formalized process for purposely directing and controlling future operations towards desired objectives for periods extending beyond one year. As for short-term planning or budgeting, must accept the environment of today and the physical, human and financial resources at present available to the firm. So, sometimes, we can see budgeting as complement process of long-term planning. According to Colin Drury, there are six major functions of budgets, says, planning, coordinating, communicating, motivating, controlling and evaluating.

3. Conflicts and problems in budgeting 3.1 Conflicting roles of budgets Firstly, I will simply introduce the conflicts between the six functions in budgets. As we know, a single budget system is normally used to serve several purposes there is a danger that they may conflict with each other [1] . The major conflicts appear between motivation, planning and evaluation. (1) Motivation The evidence shows that if the firm organization sets specific and more difficult goals in budget, it seems like to generate higher performance. In contrast, if the goals are easy to achieve, the performance would be not satisfied. Budgeting leads to bizarre and dysfunctional behavior and people do not give honest forecasts. When negotiating their targets managers aim as low as they think they can get away with, while the top team picks higher numbers in opposition [2] . (2) Evaluation and Planning In fact, budgeting as a performance evaluation tool should be based on a comparison of actual performance, but budget for planning purpose would be set in advanced of the budget period which based on the anticipate circumstance. So, the management always compares the actual performance with original budget. Consuming if the circumstances envisaged when the original budget was set have -1-


changed then there will be a planning and evaluating conflicts[3] .

3.2 Problems existing in budgets Beyond those conflicts in budgeting, there are several problems in budgets especially in the traditional budgeting, and some of them are caused by the conflicts between functions. (1) Budget as a fixed performance contract limits and affects actual performance. The budget is often used as fixed performance between subordinates and superiors, and everybody in firm eager to want achieve goals of budget, so, sometimes, the use of fixed performance contract can lead to budgetary gaming. Maybe the management will lose the long-term goals in order to achieve perfect budget goals. (2) Adaptability. This means that the firm is very hard to change the budgeting if the outside environment changing, which caused coordination and inefficiency problem. Moreover, the use of a fixed budget can act as a constraint, decreasing the firm's flexibility and ability to deal with new opportunities, threats or changes in customers' requirements. (3) Less links with strategy. Budgets are rarely strategically focused and are often contradictory [4] . It is easy to understand, as we know, the budget as a financial tool emphasizes the form’s cost and revenue, but strategy as a long-term planning more deals with the non-financial value driver. So, there is a gap between strategy and budgeting. In the reality, firms are like to separate processes for long-term strategy planning and annual budget, which accelerates the less linkage between budget and strategy. Researches show that 78% do not change their budget in the fiscal cycle [5] ; 60% do not link strategy and budgeting; 85% of management teams spend less than one hour a month discussing strategy [6] . (4) Hierarchy VS Process Budgets inevitably mirror the organizational structure of the firm and thus its focus is on the performance of functions, departments, cost centers and divisions. It results in a focus on managing by the numbers. However, this contrasts sharply with the emphasis companies now place on managing processes as the cornerstone of value creation. Leading-edge companies take a horizontal (with the customer interests in the centre) rather than a vertical (pleasing your boss) view of the enterprise. (5) Higher Expenses Budget should be prepared before the next budget or fiscal year, maybe four or five months. So, it will occupy 20% to 30% of managers’ time, and it is very hard to say the firm will receive benefits or value from budget. Come back to my topic of this paper - budgeting are barriers to change in companies that wish to devolve responsibility and respond more quickly to competitive threats and opportunities. I think this is a appearance of the adaptability problem of budget. Moreover, I think it can mirror the dysfunctional problem in the company’s internal operation. Looking at the traditional control system structure [3]:

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Strategy goals and guidance

Fixed annual budget Planning: assess financial implications Setting performance targets/commitments Authorize recourses available Keeping things

on

Coordinate units Motivation

track Control (vs. budget)

Performance evaluation and incentives (vs. budget) This chart shows that annual budget is part of accomplishment process of strategy, and through annual budget, it can play the controlling and evaluating functions. As we know, in most companies, budgeting is used as a controlling tool which keeps everything on the track, however, budget should be prepared in advanced four or five months under the anticipated and estimated environment for next budget year. So, when the actual environment or circumstance changes, it is not easy for budget changing as soon as possible. I think this is a dysfunction in control system, because the higher management sometimes does not change budgeting in accordance with outside environment, they just want to keep everything running in the way which they plan before the budget year. So, at times, I think the managements are vague the meaning of control, while controlling everything is not as same as keep everything on the fixed way, I think it should be controlled in more flexible way.

4 Better budgeting Facing these problems existing in budget, some people suggest improving the traditional budgets, and there are four major better budgeting techniques used now– activity-based budgeting, zero-based budgeting, value-based management and rolling budgeting. Activity-based budgeting and zero-based budgeting undoubtedly help to improve the focus and accuracy of budget outputs. The problem they share, however, is that they tend to involve even more work than traditional budgets - so they are best used on a "one-off" basis rather than a regular one. Value-based management appears to be more theoretical than broadly adopted approaches. Rolling budgeting appears to have the most potential as a better regular budgeting approach. A number of organizations have successfully introduced it to improve their forecast accuracy and overcome the traditional budgeting time-lag [4]. It is shown that even the better budgeting improve and overcome some of problems in budget, but there is no complete approach to solve all the problems, and one kind of improve budgeting can only overcome one or two specific problems or conflicts of budget. There are also unsatisfactory for users.

5 Beyond budgeting -3-


In 1973, Svenska Handelsbanken, a Swedish Bank, began to abandon annual budgeting or target-setting process when it was losing money, and received a success after that. With the research of abandoning budgeting, Jeremy Hope and Robin Fraser believe that the traditional performance management model is too rigid to reflect today’s fast-moving economy, and then suggest the new approach – beyond budgeting round table.

5.1 Signification of beyond budgeting Simply say, the beyond budgeting model focus on six principles that like the often disparate decision streams of strategic planning, budgeting and performance management. The six adaptive process principles of beyond budgeting are: (1) set stretch goals aimed at relative improvement (2) base evaluation and rewards on relative improvement contracts with hindsight (3) make action planning a continuous and inclusive process (4) make resources available as required (5) coordinate cross-company actions according to prevailing customer demand (6) base controls on effective governance and on a range or relative performance indicators

5.2 Why companies abandoning budgeting and choose beyond budgeting Now, more and more firms chose to abandon traditional budgeting and adopting beyond budgeting, there are several reasons: (1) Improving the ethical competitiveness Taking the notion of the frontline beyond its usual military connotations, is there any other aspect of the business with more active engagements than the budget? It touches the lives and controls the behaviors of everyone in the organization-or at least it should do so. The Beyond Budgeting process principles outlined earlier give clear definitions to at least six frontline budget-related dimensions that promote ethical competitiveness: governance, climate, freedom to act, capacity to act, responsibility, and access to information [7] . (2) Avoiding the problems in traditional budgeting I discuss the five problems in the traditional budgeting, in most companies, these problems are the biggest threats for companies operation in future, so, some companies choose abandon budgeting and use beyond budgeting to overcome these problems. It makes more close linkage with strategy through the six process principles; enables firm to respond faster and therefore cope better with uncertainty, and fast responds means making strategy an adaptive process; leads the company operation with lower cost; places customers’ value needs at the center of strategy [8] .

6 Feasibility of using beyond budgeting Budgeting as a management performance method applied in practice for many of years, it is not easy for companies to abandon it. There are obstacles to abandoning traditional budgeting? Budgeting is a tool of 'command and control'. The biggest obstacle is the unwillingness of leaders to relinquish control in order to gain the benefits of improved performance that come when people are truly responsible for their results and have the capability and freedom to act. Those few companies (like AES, the electricity generator, and Svenska Handelsbanken, the Swedish bank) that have really decentralized now recognize how difficult it was to achieve and how difficult it still is to sustain, especially when the going gets tough. But they know how great the rewards can be [9] . -4-


When the companies adopting the beyond budgeting, the change will begin in the companies where the pressures to change are the greatest. Meanwhile, Companies need to evaluate whether these represent some of the imperatives under which their businesses must operate. If so, management should find and evaluate the degree of the problems in budgeting systems.

7 Conclusions Through analysis about the topic why the budgeting sometimes becomes barriers for companies developing, I discover there are many of problems which result from the conflicts between six functions of budgets. I think it can reflect the dysfunctional problems in the firm’s organisation operation, particularly in control system. Many of companies use budgeting as strict standard to control the cost, expenditures and so on. The better budgeting can only overcome one or two problems if traditional budgets, not all the problems, such as the rolling budgeting can solve the adaptability problem. So, more and more companies are trend to abandon budgeting. Beyond budgeting is one of the most popular techniques used by companies, it solves the major strategy linkage problem. However, I do not think that all the companies are fit for adopting beyond budgeting, because some departments of firm should be controlled under the budgeting, such as producing department, and the feasibility of beyond budgeting is another problem in the companies. In fact, whether the traditional budgeting, better budgeting or beyond budgeting adopted, their effectiveness and efficiency depend on the complexity of the context in which they are used.

Reference [1]

Colin Drury (2000), Management and Cost Accounting 5th Edition, Thomson Learning, London Matthew Leitch (2003), The dawning of a new age: control without budgets, Balance Sheet, 2003, Vol.11, Issue.3, pp. 7-9 [3] Theresa Libby, R Murray Lindsay (2003), Budgeting--an unnecessary evil, CMA Management, Mar 2003, Vol. 77, Issue 1, pp. 30-34 [4] Andy Neely, Mike Bourne and Chris Adams (2003), Better budgeting or beyond budgeting? Measuring Business Excellence, Vol.7, Issue 3, pp. 22-29 [5] Hackett Benchmarking PR Newswire, Corporate strategic planning suffers from inefficiencies, 25 October 1999 [6] Robert Kaplan and David Norton (2001), the strategy focused organization. Harvard Business School Press [7] Steve Player (2004), How Does Your Budgeting System Impact Ethical Behavior? Cost Management. May/Jun2004, Vol.18, Issue 3, pp.5-12 [8] Jeremy Hope and Robin Fraser (2001), Figure of Hate (Beyond Budgeting), Financial Management (UK), Feb 2001, pp. 22-26 [9] Alf Oldman, Roger Mills (1999), Abandoning Traditional Budgeting, Management Accounting, Nov 1999, Vol.77, Issue. 10, pp. 26-27 [2]

Introductions for authors: Yang Liang (1981- ), female, master in School of Humanities and Economic Management, China University of Geosciences, Beijing. Major in economics and HR management. Yan Wang (1981- ), female, master in Department of accounting and finance, Napier University, Edinburgh in UK. Major in management accounting.

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