Traditional budget

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TRADITIONAL BUDGET 9

A traditional budget is a form of financial planning that has beenin existence for numerous years. A traditional budget provides a planfor the usage of funds or income which is yet to be realized. Thisplan is normally for a specified period such a month or a year. Thebudgeting process requires that records be kept which will indicatewhether the funds were used according to plan (Otley, 2001). Atraditional budget does not allow expenditure to surpass the plannedamount. In a traditional budget, resources are allocated accordinglyto the various expenditure avenues in an organization. Opponents ofthis form of planning have argued that this budget is rigid and isnot fit for the current dynamic business world. In other words, thisbudget appears to be fixed and does not allow any alterations orvariations to fit into the demands of a changing business world. Thetraditional budget assumes that there will be no spending whichexceeds the income. In instances where there is additional income,the traditional budget plan proposes that such monies be saved. Therigidity of this budget is what has raised numerous issues regardingits usefulness (Otley, 2001).

There are proposals from opponents of the budget that it should beabandoned. The following are arguments that are presented by theopponents of the traditional budget. To start with, the traditionalbudgeting process takes immense time and resources of anorganization. Research has indicated that the traditional budgetingprocess is not only time consuming, but it also takes immense usesnumerous organizational resources. The Beyond Budgeting Round Tableor what is largely known as the BBRT asserts that in mostorganizations, the budgeting process takes up to 30% of the managers’time (Van der Stede, 2000). Additionally, the traditional budget issaid to involve numerous people across the company hence consumingnumerous company resources. Despite the traditional budget taking allthis time and resources to prepare, research has indicated that itdoes not yield the desired results. The traditional budget setsstandards of costs and rewards or praises employees who operate underthe budget. This aspect has been associated with lack of change andflexibility.

The traditional budgets are inflexible and hard to change.Considering that the traditional budget is a detailed document thattakes almost more than a third of the year to prepare, it is evidentthat this would be difficult to change. The process of making changesto the budget is almost impossible. This implies that the employeesand the managers alike must stick to the budget (Ryan, 2007). Whenchanges occur in the market, such as new entrants into the business,or change of policies, the traditional budget does not allow changesthat would go along with such variations. This makes the traditionalbudget an extremely ineffective tool in today’s businessenvironment which is not only vibrant, but also dynamic. For instancein the Statoil case, the managers were rewarded for operating underthe budget. Whereas this may seem like a noble thing, it is essentialto look at the other side of the coin (Otley, 2001). The manager istied by the budget and this prevents him to carry out explorations ofnew deposits which would ensure that the company is competitive andsecures sources for the future. In this scenario, the traditionalbudget’s rigidity is clearly brought out. Organizations that stickto budgets are stagnant and are slow to react to market changes.

The traditional budget setup assumes that things will remain thesame as they were when the budget was created. This is a wrongassumption which leads to organizational failures and lack ofcompetitive advantage in the market. In today’s business field,there might be new innovations, new competitions, new partners orinternal variations that will have financial repercussions. Thetraditional budget is ineffective in that it does not factor in thesepotential changes which might have an effect on the finances of theorganization. According to BBRT, there are 55% of managers whobelieve that the budget is ineffective and is only applicable in thefirst six months of its creation. This is due to the vibrant businessenvironment (Ryan, 2007).

The traditional budget’s main role and purpose is to reduce thecost in any organization. This implies that the focus of the budgetmaking committee is to find ways of reducing the cost rather thanfocusing on the various strategic plans that would push theorganization ahead. As a result, the traditional budget makesnumerous organizations and managers to fail in the market as they donot focus on aspects such as customer satisfaction. The creation ofvalue in the budget controlled and run organizations is not apriority. In today’s business world, it is essential to havestrategies that will create value in the customers (Ryan, 2007). Thisis done through using resources to improve customer relations throughquality products, acting on customer feedback, engaging in corporatesocial responsibilities and engaging in intensive marketing andpromotion activities. The traditional budget limits the managers andthe employees alike from engaging in such activities in a bid to cuton the cost. These have adverse repercussions on the progress thatsuch an organization can make in the vibrant and competitive market.It is worth noting that numerous European companies and somecompanies in America are doing away with the traditional budget dueto the inefficiencies that it presents (Otley, 2001).

Every company will focus on how well it can adapt to change in orderto remain competitive in today’s market. It is worth noting thatchange requires resources to be implemented. This is because some ofthe changes involve adopting new technology, developing alternativemarketing strategies or even employing additional staff. It is clearthat all these changes will call for financial support. In majorityof the companies where a traditional budget is the order of the day,the budget is prepared annually and it is hardly reviewed toincorporate any changes (Ryan, 2007). Once the budget is made, it ismade almost obsolete and this makes reviews impossible. In instanceswhere there might be reviews, it is worth noting that the reviews arenot real time and they take enormous time. This is due to the factthere are numerous people involved in the budget making process whomust be consulted while making reviews. This implies that the changesmade to the budget might not be timely and might not be effective inreacting to the changes that they were intended to address. Therigidity of the traditional budget and the inefficiencies that itbrings along are increasingly becoming clear.

The traditional budget is largely internal and it sets growthparameters internally. This implies that it is possible to have agrowth target of 10% in a company while other competitors have atarget of 20%. This is clearly unacceptable. When the seniormanagement realizes such, it is difficult for them to make anychanges to the budget to accommodate any increment in the financingof additional strategies that would bring along the required growth.There is need to ensure that the planning committee looks at theexternal environment before setting the targets for the organization(Van der Stede, 2000). It is worth noting that organizations budgetin accordance to their internal resources. This implies that thetargets set are not based on competitors. Another downfall to thisform of budgeting is that even if there were steps that theorganization would take which would lead to improved growth, they aresimply ignored due to financial constraints.

The rigidity of the traditional budget ties performance andremuneration to the budget and to the targets set by the budget. Thisis an extremely dangerous trend in the business world since managersand employees are forced to work within levels that will not surpassthe budget. Managers of various departments are allocated specificamount of resources which they must not exceed. This implies that themanagers are tied and cannot take any steps which can lead tooverusing the allocated amount (Ryan, 2007). Consequently, manageswho use less than what they were allocated may engage in unnecessaryactivities which are aimed at spending the remaining amount. It isclear that this will lead to enormous wastage of the organization’sresources. The opposite aspect of this is true when managers believethat the resources allocated are dwindling and they are yet toaccomplish the set targets, they will likely squeeze the resourcesfor various projects hence leading to underperformance. This is aclear indication that the organization will not perform as expectedand will end up being outdone in the market by the competitors. Insome organizations, managers are rewarded for spending less than whatwas allocated in the budget (Chong et al., 2006). This means that themanagers are not creative in their work and in most cases theyunderperform. The budget does not focus on performance, but itfocuses on the usage of the money that was allocated for a particularpurpose.

The rigidity of the traditional budget denies does not follow themodern approach to a vibrant business world where money is allocatedwhere and when it is needed. In a rigid traditional budget, money isallocated once per year and this means that the manager cannot takerisks in venturing into new actions (Byrne, S. &amp Damon, 2008).Additionally, the managers cannot deviate from the proposed actionsin the budget since this would mean that they will not meet thebudget. Organizations have lost opportunities due to the rigidity ofthe budget. According to Henry R. Byers, Professor of Business, thetraditional budget creates what is called a fixed performancecontract (Van der Stede, 2000). This is a situation where themanagers are supposed to meet certain set sales, costs and othervital ratios. The managers are cautious not to surpass the setstandards as this would end up risking their jobs. It is worth notingin the traditional budgets, the allocation of resources for upcomingyears relies on the expenses of the current year. Manager would notwant their budgets to be reduced and therefore they end up incurringcertain unnecessary costs in order to retain the budget at a certainlevel. As much as the budget is aimed at cutting costs, it is clearthat this trend brings in a different perspective. Managers ensurethat there is a floor for the budget (Byrne, S. &amp Damon, 2008).In other words, the budget hardly reduces for the companies that relyon the traditional budgeting process.

There are a number of companies in the United States that have beenvictims of the traditional budgets. An example is the Northern QuestResort &amp Casino which has for long relied on the budget as a toolfor setting targets and assessing performance. Tim Quinn, the financevice president of the company states that the traditional budgetconsumed immense time and resources where over 40 departments wouldbe told to send in their projected expenses and revenues (Byrne, S. &ampDamon, 2008). Tim asserts that most of the departments would send inexaggerated expenses and Tim and his team would have to adjust thefigure according to the historical expenditures of the company. Thefinance vice president states that the budget was highly ineffectiveand managers would only work towards meeting the targets rather thandoing their best at work. It is also clear that the company wouldalways allocate resources which were not required since the managerspresented exaggerated budgets. However, the finance vice presidentdecided to do away with the budget and adopted a more responsive andmodern approach, rolling forecast, which is being adopted by numerouscompanies (Otley, 2001). This is an approach that allows forquarterly reviews and allows for a flexible allocation of resourcesto arising needs. Tim states that this change has already yieldedresults as managers have started to focus on strategies to enhanceperformance.

s are something that major companies shouldforget. The Beyond Budgeting Round Table asserts that large companiessuch as Enron Energy Company failed due to the targets that were intheir budgets. This forced the company to borrow and fabricate thebooks of accounts to show that they were meeting the targets. Moderncompanies which are aware of the dynamic market environment mustadopt the more flexible planning methods such as the rollingforecasts (Van der Stede, 2000). This will ensure that the seniormanagement of organizations can respond to changes and remain beingcompetitive in the market. The problem with the traditional budget isits rigidity which implies that there nothing that can be changed orreviewed to fit into the upcoming demands.

In conclusion, it is clear that the traditional budget is a toolthat is not worth taking time and allocating resources to prepare.Today’s market and business environment is extremely vibrant andtherefore it requires businesses that can react quickly to thechanges. It is vital for budget committees in various organizationsto realize that the budget estimates are unrealistic and do notreflect the real expenditure or sales that an organization will face.It is clear that numerous multinational companies across the worldare following this trend and are realizing the weaknesses that areposed by the traditional budget (Otley, 2001). Large companies whichhave relied on the traditional budget have failed miserably sincethey were unable to respond to the changes in the market. A goodexample is Blackberry which was once a major competitor in the phonemanufacturing business. However, it is worth noting that the companyhardly relied on changing the traditional budgeting process and endedup struggling in the market.

References

Otley, D. (2001). Extending the boundaries of managementaccounting research, British Accounting Review, 33, (2001), pp.243-261.

Van der Stede, W. (2000). The relationship between twoconsequences of budgetary control, Accounting, Organizations andSociety, 25, (2000), pp. 609-622.

Ryan, B. (2007). Budgeting, the individual and the capital market:a case of fiscal stress. Accounting Forum, 31, (2007), pp.384-397.

Byrne, S. &amp Damon, F. (2008). To participate or not toparticipate? Voice and explanation effects on performance in amulti-period budget setting’ [Online], The BritishAccounting Review. Accessed from: http://www.sciencedirect.com/science/article/pii/S0890838908000383

Chong, V. K., Eggleton, I. R. C. &amp Leong, M. K. C. (2006). Themultiple roles of participative budgeting on job performance’[Online], Advances in Accounting. Accessed from: http://www.sciencedirect.com/science/article/pii/S0882611006220042

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