The advantages and disadvantages of using traditional budgeting
Traditional budgeting is one the first budgeting systems created. Traditional budgeting system is still commonly used in many organizations today. The reasons why organizations still using traditional budget, this is due to framework of control. The role of the budget is to give focus to an organization, and help the coordination of activities and enable control. Large companies might struggle to plan, coordinate and control their dealings without a budgetary system. Even smaller companies can benefit from the budgetary system to ensure the direction of the business, and how it can reach its goals.
Second reason is its organizational culture; for the fundamental method of operating, it may not be possible for the organization to move away. Moreover, by their nature, budgets are a centrally coordinated activity within a business, and often the only one which brings together all aspects of the company. Budgets are often the one process which covers all areas of organisational activity (Otley, 1999).
Third reason of an organization still using traditional budgeting system is the need to decentralise; this is recognized that banks institutions and other financial institutions are more suitable candidates for decentralisation than other types of businesses. For an example, Norman Macintosh observed that branch managers at Transamerica Finance Corporation had a great deal of freedom to run their operations according to standard operating procedures. Similarly, another example is Svenska Handelsbanken, the largest bank in Sweden sets parameters for branch managers’ discretion and then motivates its staff using competitive devices such as branch league tables (Alexa Michael and Technical Information Service, 2007). This approach can be successful in organizations where people work in similar but in independent units. However, it does not follow that this level of decentralization can be adopted by all organizations. Every organization is unique and it may be impossible to change the company culture to provide the necessary decentralisation. Successful decentralisation also depends on a great deal of trust being invested in teams throughout the organisation.
Due to economic uncertainty, traditional budgeting has its limit. The disadvantage of traditional budgeting is it has insufficient external focus. Traditional budgeting is seldom focusing on strategy and is often conflicting. Besides that, it is time consuming and costly to put together, and also limit responsiveness and flexibility, whereby this is not good for economic uncertainty situation. This is because it often discourages change and only adds little value, budget tend to be bureaucratic and discourage creative thinking and requires too much valuable management time. Traditional budgeting system has an adverse impact on management behaviour, which can become dysfunctional with regard to the objectives of the organisation as a whole. Johnson (2005) explains that most budgets are not based on a rational, causal model of resource consumption, but are often the result of protracted internal bargaining processes. Conformance to budget is not seen as compatible with a drive towards continuous improvement.
Under economic uncertainty, inflexibility is somehow seen as the key failing factor of traditional budgeting, and organizations are being urged to move towards continuous budgeting systems to enable speedy and coordinated adaptations to actual and anticipated changes in the economic (Neely et al, 1997). Continuous budgeting system gives companies the agility and capability to follow changes in market situations, and to cope with economic uncertainty while keeping an eye on strategic objectives (Lorain, 2010).
Continuous budgeting system solves problems associated with infrequent budgeting and hence results in more accurate forecast. It is also more responsive to changing circumstances under economic uncertainty. Some companies use a continuous budget which means that a ongoing 12 months budget is presented by consecutively adding a new budget as each current month expire, such a process allow management to work at anytime, within the present 1 month component of a full 12 month annual budget. Continuous budgeting system make the planning process less irregular, rather than having managers go into the budget getting period at a specific time, managers are continuously involved in planning and budgeting process. The advantages of a continuous budget under economic uncertainty situation include, eliminating a fiscal year mind set by recognizing that business is an ongoing operation and should be managed accordingly. It also allows management to make corrective steps as forecast business condition change such as in economic uncertainty. It helps to reduce or eliminating the budget planning process that occurs at the end of each fiscal year.
Another recent survey jointly conducted by the American Productivity Quality Centres and IBM Global Business Services has found that companies focusing on planning, budgeting and forecasting as a business strategy are higher performers in all area than those focusing on cost accounting, control and cost management. The study also showed that high performing organizations tend to complete their budgeting cycle in 30 days compared to 90 days in low performing organizations and most of the high performers used continuous budgeting system when the economic in uncertain (Kinney and Raiborn, 2008).
Another example in the article author has mention how Kenyan business sail through under economic uncertainty. Kenyan have experience challenging times with business struggling to plan and price their product carefully so as not to erode the profit margins that they had planned for. Having exchange rate problems. Smart cfos employ a budgeting, principally a set of procedures used to develop budget. Author mention that Kenyan organization have limited resources and and they need to effectively plan and use them. This is why they implement budgets to help provides a means to achieve this. Budgets provide a useful benchmark of performance and help control profit and operations when compared to actual performance. The resulting variance guide management in appreciating what they need to do in the subsequent period. Employee performance and managerial performance is usually measured on qualitative terms, but budget gives a new meaning to evaluate performance through numbers and helps in rewarding high performers and correcting the low performers. Due to the economic downturn, a number of well run companies have adapted to their specific circumstances and prepare master budget that comprises of performance financial statement, a capital budget, and a financial budget. However, some organizations have adapted to the concept of continuous budgets. With the fluctuation of the dollar, business are emploting a variety of techniques of budgeting to ensure that they make profits.
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