This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.
"A budget is a business plan for the short term-typically one year."(Atrill & McLaney ,2007, p304) It is mainly expressed in financial terms and it is designed to meet the strategic purpose. Budgeting plays a vital role in business success as it helps in the organization's operational planning, performance evaluation, communication of goals, strategy formation, and controlling cost which helps the organization to achieve its overall objective. But it seems it is unsuitable for the modern business. This essay will include a brief induction for traditional budgeting and then discuss the strengths and weaknesses of traditional budgeting, following which it will explain and evaluate the alternative.
'Modern business' stands for a business which operates in a global economy and practises all modern techniques to survive in a highly competitive environment. In the era of information technology it is impossible for a business to compete globally without continuous innovation, updated information and controlled activity.
What is traditional budgeting?
Budget is a part of strategic planning process. It lays down business objectives, targets and decides activities required to achieve these objectives. Traditional budgeting is based on previous year data, decisions, uncertain estimates and forecast (Drury, 2009).Traditional budgeting is basically one year planning which lays down targets for the business and at the end of the year these targets are compared with actual results and deviations, if any, are reported to the budgeting team which uses them as an important source of information for current year budgeting. Traditional budgeting creates boundaries for the business operations and sets targets for its employees, which motivates employees to work hard and earn rewards for their achievement.
Importance of Traditional Budgeting:
Kennedy (2009) in his study on budgeting found out that 99% of all companies in Europe still using formal budgeting system. Budgeting provides a direction which can be used as a framework for planning and controlling the overall activity of the business. Budgeting is often used as an important tool for controlling cost and expenditure of the business ,which is very essential for an organization to survive in a competitive world. It is also used as a tool to maintain liquidity position of the firm by matching business revenue against expenditure, which gives an actual position and requirement of cash at a definite time period. Kennedy (2009) in his study also points out that it is the multiple function of budgeting which makes it an important tool for management. Budgeting provides a system of authorization, a means of forecasting and planning, it also provides a channel of communication and coordination through which the actions of different parts of an organization can be brought together and reconciled into a common plan. Kennedy's study also states that budgeting serves as a tool of motivation, a system of evaluation and control, which acts as a useful source of information for decision- making.
Limitations of Traditional budgeting:
Budgeting is always being criticized for its high cost and the longer time it takes for its preparation. These two limitations are always a point of consideration for business organizations, which require a long working of financial managers and which incurs heavy charges on the company. In addition to this, budgeting is criticized in many other aspects as well. Dugdale ( ) in his study on budgeting points out that budgeting being an important tool for an organization has many limitations like, it meets only the lowest targets, it uses more resources than required, it competes against other divisions, business units and departments, also it spends only what is in the budget, provides inaccurate forecasts, has motives only to meet the budget but not to beat it and finally it also avoids risk element. Bourne (2002) conducted a survey on limitations of traditional budgeting in which he criticizes traditional budgeting on a number of issues. From the survey result, he pointed out the following criticisms against budgeting ; its time consuming, costly, restricts flexibility in operation, its very often focused on target and often misaligned with strategy, it focuses more on cost rather than value creation, it often encourages gaming between superiors and subordinates, it is hardly updated and is based on unrealistic assumptions and guesswork which make it unsuitable for modern business.
Traditional budgeting and modern business:
'Budgets have long had a bad press, but they have attracted even more flak recently for being at best inappropriate to modern business practice and at worst potentially harmful' ( ,2005). Modern business requires innovation alongwith cost saving in order to be competitive enough to fight with its rival company.
Marginson (2005) in his study on budgeting and innovation argues that 'how firms are balancing the need to control costs on the one hand with the pursuit of innovation on the other'. That is, modern business is an era of global business and competition which requires continuous innovation and huge spending on
R & D for its survival. And if modern business follows the budgeting tool it will restrict the business from spending a huge amount on innovation , and this becomes a major criticism of budgeting. ( Hopes & Fraser In: Ekholm) added that 'traditional budgeting is incapable of meeting the demand of the competitive environment in the information age.' This means, traditional budgeting is useful accounting model with its focus on command and control but its lack in providing useful updated information like market changes, change in taste and preference, change in technology, etc. which makes traditional budgeting unsuitable for modern business. (Hopes and Fraser In: Ekholm) further added that traditional budgeting is a time consuming process and therefore fails in reflecting changes fails in reflecting changes in the company's organization process. As a result it 'produces inadequate variance reports leaving how and when question unanswered'. That is, ignores shareholders value and focus more on short term financial numbers. It follows a risk avoiding culture and therefore faces a false sense of security as yearly, rigid process and being toy of accounting department. Ekholm( ) in his study about budget find out that traditional budget is seems to burden, and therefore must be removed from financial reports, before improving financial performance.
(Hopes & Fraser In: Dugdale ) says that if companies want to meet the modern business challenges then they must dismantle their ' rigid command and control structure, which means scrapping their budget and should adopt a policy of radical decentralization and implement appropriate key performance indicators, scorecards and rolling forecast.'
Alternatives to budgeting:
Rolling forcast, produced a monthly or quarterly basis, are suggested the main alternative to the annual budget (arterion,1998, hope and fraser 1990-20 In, Ekholm). Limitations of traditional budgeting give rise to many beyond budgeting techniques like, rolling forcast, zero based budgeting, activity based budgeting, process based budgeting and performance based budgeting.
Importance of budgeting in modern business:
Dugdale and Hanseenfrom their study find out that budgeting still alive and operational planning, performance evaluation, communication of goals and strategy formation are its important functions which helps it being alive in modern business. Ekholm from a questionnaire survey on budgeting finds that traditional budgeting is needed in modern business as it is a important tool for maintaining internal effectiveness which is needed to maintain long term equilibrium position of the company. He also finds out that modern business still require traditional budgeting because it targets can't be set for people. That means, no control and no performance evaluation can be done. Hanseen ( from his study finds out that there are different reason to budget like ' market related performance (sales growth, market share) and internal operation related performance (cost effectiveness, quality), which seems to be important reason for its wide use in modern business as it will help company to achieve competitive advantage over its rival. Dugdaleas a conclusion of case study point out that budget is an important tool to set resources limit for function such as service and R&D, which will help business to make efficient use of their limited resources that will lead to success for a company in this competitive world.