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A budget is a financial statement used to plan or forecast an organisation's income and expenses in the future. Normally a budget can be prepared either yearly, quarterly, or monthly. Budgets are useful for an organization because budgets can help an organization in planning and controlling their daily operations and also to support organisation's managerial strategies.
Many companies use budgets as a profit plan to achieve their objective and goals because budgets can predict whether the activities operate by an organisation will obtain a profit or loss. For example, companies can use budget to compare the budgeted sales with the actual sales to determine whether the company had make a profit or loss after the project has been carried out.
Besides, budgets helps to control organisations from being overspending in unnecessary or less productive areas and invest more assets in those areas that can earn better income. Usually, the managers from each department will handle the budgeting during meetings or discussion with managers.
Although budgeting helps many organizations in their daily operations, however budgets are often unpopular. This is because budgets are too time consuming. Employees and managers need to spend most of their time on preparing budgets and put more effort to negotiate them and explain all the variances.
2.0 Benefits of Budgeting
An organization's plans and goals will be expressed in budgeting process in which budgeting provides various benefits. Manages therefore are required to understand the use and the importance of budgeting when they involved in the planning activities of an organization. The benefits of budgeting are as follows:
Communication and Coordination
Communication is a useful tool in which can be use to exchange information and idea to ensure that the organization's plan runs smoothly and effectively. An effective budget processes communicate is either from upper-lower level managements or from bottom-upper level managements or combine both of the two approaches (Horngren et al., 2008). In an organization, budget helps managers to coordinate activities in each department. An organization's goals and objectives will communicate by upper level managements to lower level managers and employees to coordinate the activities (Ainsworth et al., 2009).
For example, the implementation of Connectiva AFFIRM systems from YTL Communication Sdn Bhd is a solution to help the enterprises in enchance profitability, minimize fraud and prevention of revenue leakage (Chaudhary, 2010) [Online]. This Connectiva System help YTL Communications to manage its revenue assurance processes (Chaudhary, 2010) [Online].
Budgeting helps managers in planning decisions for the future. In order to accomplish the various activities, managers in an organization are required to consider and produce detailed plans for possible future courses of action in budgeting process. For example, to remain competitive, Apple's R&D budget keeps on increase year-over-year that is a total of $782 million in 2007 had increased to $1.1 billion in year 2008 (MacBlogz, 2008) [Online]. The purpose of increase the R&D budget is to design and produce more type of products they want to sell to customers in the future.
There are many resource allocation decisions need to be done during the budgeting process. The resources of an organization are very limited and resources for capital expenditure may require from different segments due to the organization unable to meet the requirements. Therefore, proper planning and effective budgeting are very important so that organizations' resources can allocate the resources or services according to their applicability (Ibrahim et al., 2008).
Basis for performance evaluation
A Budget is used as a benchmark to evaluate the performance of a department or employees in order to pursue the goals and objectives (Ibrahim et al., 2008). Whenever there are any variations, managers attempt to determine the cause of the divergence and seek for the better solution to improve the performance of a company so that they are able to achieve their goals and objectives. Some companies may award bonuses to employees according to the periodic budgets and it's usually depends on their ability to achieve the targets (Drury, 2005). In addition, budget is quiet useful for managers who may wish to evaluate their job performance in meeting targets (Drury, 2005).
A budget is used to motivate managers and employees to achieve their goals. In order to achieve organization goals, management set a benchmark based on the budget so that it can motive employees to put more effort and work hard towards their jobs by providing a challenge (Ibrahim et al., 2008). To gain extra incentives, employees sometimes will strive hard to achieve more than budgeted target (Ibrahim et al., 2008).
2.1 Supports for Budgeting
Budgeting is at the heart of the performance management process for most companies. Today, many companies are dissatisfied with the use of budgets. Overall, there are total of 40 companies' financial and non-financial managers in UK were surveyed by Dugdale and Lyne (2006) had come out with a main conclusion that budgeting is alive and well (Drury, 2009). Financial and non-financial in 40 companies thought budgets were essential for planning, control, performance measurement, coordination and communication (Drury, 2009). Yet, managers tended to disagree that budgets provided too little reliable or no value of data (CIMA, 2007) [Online]. However, most of the managers agree that there are few areas of budgets were problematic, when Dugdale and Lyne (2006) doing a survey to find out how problematic does both financial and non-financial found their budgets (CIMA, 2007) [Online]. These are such as:
Budgets are too time-consuming (CIMA, 2007) [Online]
Budgets might constrain managers and necessary actions might be delay (CIMA, 2007) [Online]
Budget process is indispensable due to managers largely regarded budgets although budgets bring problematic to an organization.
Other research done by Dugdale and Lyne (2006) has claims 99% of Europe companies do not intend to abandon budgeting since they have a budget in place [Kennedy and Dugdale in Vuorinen (1999) as cited in CIMA (2007) [Online].
2.2 Successful Company Practicing Budgeting
International Business Machines Corporation, also known as IBM Corporation is one of the best-practice and most successful company in budgeting, planning and forecasting processes. IBM Corporation has implemented a software called "IBM Cognos 8 planning" that helps many companies to analyze their budgets, plans and forecasts fast and efficient (IBM, n.d.) [Online]. For example, the Philadelphia Care Foundation, a Dutch organization that helps those people who needs care and support, without concerning the age, cause and disability (Player, 2008) [Online]. IBM Cognos 8 planning allows and helps Philadelphia's managers to easily budget and it's a useful software for them to review personnel cost per location, easily change data and so on (Player, 2008) [Online]. With the use of the software, Philadelphia Care Foundation is now can prepare their budgets more efficient and can even work with multi-year budgets (Player, 2008) [Online].
3.0 Weaknesses of Budgeting
Although budgeting has brought benefits to a company, but there are still some weaknesses exist. According to a research by Cranfield School of Management, 80% of companies are not satisfied and not happy with their current budgeting (SAICA, 2007) [Online]. This is because budgeting takes too long hours to complete it, provide too little reliable and no valuable of information, and incentives to lie and cheat to meet targets, and difficulties of obtaining accurate sales forecasts.
Being time-consuming and expensive ( Drury, 2009)
A company need to spend a lot of time when they practicing budgeting. There are many repetitive steps in the development of budget are required to be done before the budget is approved from upper level of management. For example, budgeting involves each level of managers (i.e sales managers, production managers, and so on) in an organization to develop their own budgets for sales, production, cost and etc (Langfield-Smith et al., 2006). Discussion and negotiation are required among the manager at different levels until a properly planned budget issued and is acceptable by the employees in the company. Some studies (by KMPG) believe that budgeting process can spend up to 30 % of management's time (Daum, 2002) [Online]. The sum of $1.2 billion had spent annually for budgeting by Ford Motor Company (Hope et al., 2003). Naude (2007) as cited in SAICA (2007) [Online] remarks that Microsoft Gold Certified's employees takes 8 months to complete the budget even though they familiar with their company.
Too little reliable and no valuable information is provided (Hope et al., 2003)
Budgets are prepared based on assumptions. Therefore, information turns out to be inaccurate. In general, budgets are backward-looking and inward-oriented, this will cause irrelevant and unreliable information will inevitably provide to the users. Sometimes, problems may also occur when there are inadequate of time to analyze data and too little of time was spent by employees in value added. A study from 1999 global best practices had proven that 79% of finance staffs spent their time on valueless activities while they spent the rest of 21% of their time in analyzing the numbers (Hope et al., 2003). This could be the reason why the finance staffs submit their unreliable information and sometimes even no value of information to the management in an organization.
Incentives to lie and cheat to meet target (Horngren et al., 2008)
The purpose of using budgets is to provide targets for managers so that they will strive hard to reach the target. However, due the incentives offered, managers misuse the budgets by creating budgetary slack (budget padding) to overstate or understate the value so that they can play with the figures around to achieve their targets easily (Horngren et al., 2008). Reporting wrong value in budgets by managers or employees (also known as cooking the books) could lead to unethical behaviour (Hope et al., 2003). Study case such as Enron's fraud. Enron bought National Westminster Bank's shares (NatWest) (Anon, 2008). Enron took $20 million, but only paid $1 million to NatWest. The balance of $19 million gave to the employees of NatWest, several executives and their families (Anon, 2008). Due to illegal practice, Enron Corporation went in bankrupt in year 2001 (Anon, 2008). Few years back, the Office of Federal Housing Enterprise Oversight (OFHEO) had brought a legal action against Fannie Mae employees (Seib, 2008) [Online]. This is because in order to trigger bonuses for senior executives, they intentionally overstated or understated the financial reports to achieve earnings targets (Alford, 2003) [Online]. These can conclude that setting too high targets will bring a negative effect when the employees are trying to achieve the target (Ibrahim et al., 2008).
Difficulties of Obtaining Accurate Sales Forecasts (Horngren et al., 2008)
It is not easy to forecasting sales. A company should know that the accuracy of a budget is depends on the dollar sales volume of budgeted sales (Anon, 2006) [Online]. Historical data such as previous sales reports, accounting records, financial statements and etc are needed for a company to obtain accurate sales forecasts. Sometimes, managers in an organisation may meet undesirable forecast either in overachieving or underachieving the sales forecast. Poor forecasting may cause problem occur during supply in production. Besides, Governments also face the same problem as in achieving the sales forecasts (Horngren et al., 2008). For example, variety of factors is needed to budget the city incomes, such as traffic fines, predicted property taxes, license fees and parking fees (Horngren et al., 2008).
3.1 Beyond Budgeting
In today's modern world, the ways and techniques companies operate now are very different compared to 80 years ago. The creation of beyond budgeting regards end the existence of traditional budget. Beyond budgeting has been created in late 1997 (Hope et al., 2003). The creation of beyond budgeting is to improve management control and performance within organizations in daily operations.
The Beyond Budgeting Round Table (BBRT) was also established in late 1997 to help its member to overcome their frustration and dissatisfaction with traditional budgeting (BBRT, n.d.) [Online]. For example budgets absorb too many management's time and it's too costly; budgets encourage to unethical behavior, difficult to obtain accurate sales, and so on (Daum, 2003) [Online]. In Europe, there are few companies have abandoned traditional budgeting due to the weaknesses of traditional budgeting processes. There are many organizations such as Rhodia, Borealis, Svenska Handelsbanken, Volvo, IKEA and many more that do not practice budgeting, but they remain successful (Hope et al., 2003).
The combination of the 2 processes such as radical decentralization and adaptive set of performance management processes are goals of abandoning the traditional budgeting process (Anthony et al., 2007). Radical decentralization enables to design a brand new working environment compared to traditional budgeting, such as a self-managed with multitask, performance accountability and develop decision-making (CIMA, 2008). Besides, a set of performance management process promotes managers to lead more towards to dynamic processes and performance accountability (BBRT, 2010) [Online]. These processes will lead to better customer service, higher productivity, reduced gaming, less waste and fast response (Daum, 2003) [Online].
2.3 Successful Company Practicing Beyond Budgeting
Svenska Handelsbanken, a Swedish bank, is one of the most successful banks in Europe that did not practice budgeting for over 30 years since in the year 1972 (Hope et al., 2003). In 1997, Svenska Handelsbenken had about $2 billion of revenues, $1.2 billion of pre-tax profits and over 20% of return on equity (Hope et al., 2003). They involving a combination of radical decentralization and adapts new management processes (Hope et al., 2003). With the combination both of the processes, this allow Svenska Handelsbanken to response the market trend and customer requirements with fast and efficient (Hope et al., 2003). Svenska Handelsbanken is one of the successful banks in Swedish, despite its abandon budget.
Today, budgeting plays an important role in company's financial and every company should practice budgeting. But, many companies dislike and hate budgeting, as they think that budgeting is too cumbersome and provide too little reliable or no value information to company. However, this is not true. Budgets is just like a road map provides all those details or information and shows where the business currently is, where does the business actually want to go, and how the business get there. Let's put it in this way, managers will found that budgeting actually allows companies to achieve their objective and goals when they run their projects.
An organization will not have any idea of what they had spent if they did not practice budgets. Managers and employees should aware of what they had spent, allocate company's funds and keep all the sales reports, accounting reports and so on in a proper way, so that it would make the works much more easier when preparing monthly, quarterly or annual budgets report.
Budgets like a list showing the details on which type of income or expenses that a company had received or spent. A Company can set targets for their spending when activities or projects are performed. For example, a budget allows a company to control over the costs if they had overspending. Using budgets will help company to achieve their financial goals.
Last, but not least, budgeting is just like a financial survival tool in "business's daily life" and due to advancement of technology, budgeting is start growing slowly. Although many organizations critically criticize budgeting, however, budgeting still widely use in the business world.