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A budget is a detailed plan that shows the financial consequences of an organisation's operating activities for a specific future time period. A budget acts as a financial model that summarises future operations, and it is usually viewed a s a core component of an organisations' planning and control system.
PURPOSES OF BUDGETING
In the budgeting process, managers in every department ask for the resources they need to achieve their goals. They explain to their superiors why they need these resources and also tell how they will complete their job. The communication between superiors and subordinates helps affirm their mutual commitment to company goals. In addition, different departments and units must communicate with each other during the budget process to coordinate their plans and efforts. For example, the MIS department and the marketing department have to agree on how to coordinate their efforts about the need for services and the resources required.
Different units in the company must also coordinate the many different tasks they perform. For example, the number and types of products to be marketed must be coordinated with the purchasing and manufacturing departments to ensure goods are available. Equipment may have to be purchased and installed. Advertising promotions may need to be planned and implemented. And all tasks have to be performed at the appropriate times.
A budget is ultimately the plan for the operations of an organization for a period of time. Many decisions are involved, and many questions must be answered. Old plans and processes are questioned as well as new plans and processes. Managers decide the most effective ways to perform each task. They ask whether a particular activity should still be performed and, if so, how. Managers ask what resources are available and what additional resources will be needed.
Once a budget is finalized, it is the plan for the operations of the organization. Managers have authority to spend within the budget and responsibility to achieve revenues specified within the budget. Budgets and actual revenues and expenditures are monitored constantly for variations and to determine whether the organization is on target. If performance does not meet the budget, action can be taken immediately to adjust activities. Without constant monitoring, a company does not realize it is not on target until it is too late to make adjustments.
One way to evaluate a manager is to compare the budget with actual performance. Did the manager reach the target revenue within the constraints of the targeted expenditures? Of course, other factors, such as market and general economic conditions, affect a manager's performance. Whether a manager achieves targeted goals is an important part of managerial responsibility.
Two widely accepted research results on corporate organisation structures set the framework in which the recent concepts of budgeting can be understood:
1) The appropriate organisational structure to face the requirement for flexibility is the network company, a rather non-hierarchical network of strategic business units or investment centres. This network is hold together by an internal market and a visionary CEO
(or board) that directs the company by means of corporate culture and investment allocation.
2) Management information systems play an important role in the success of this concept, with issues such diverse as
a) executive reward systems which conform to shareholder value
b) systems to measure strategic performance
c) adaptive financial forecasting.
Against this background and as responses to the shortcomings of traditional budgeting, we can discuss the following three models of budgeting.
i. IT automation
This approach sets in at the technical course of budgeting. Its objective is not, to change the process of budgeting itself, but to make it run faster and less expensive and thereby improving the cost-benefit-ratio of budgeting in general.
Main principles of this approach are:
1) Company-wide integration of databases
2) Topical coverage of actual data (decentralised via web interfaces or automated via sensors)
3) Sophisticated and largely automatic analysis that produces customized reports for different addressees
4) Integration of the budgeting process into groupware and process management tools
In many cases, the introduction of an automated IT systems goes along with process reengineering efforts. The objective is to make the budgeting process as smooth as possible by designing processes in which computers and information systems offer wide support and orientation for the people who are involved in budgeting.
All in all, the fundamental assumption, which underlies this approach, is that budgeting is mostly lacking of efficiency and convenience. It does not tackle any inherent difficulties in the traditional budgeting concept itself.
ii. Better Budgeting
We find a variety of methods, each tackling one or more of the shortcoming of traditional budgeting.
1) Variable Frequency Budgeting
This concept takes the fact into account that some business units live in a more dynamic environment than others. It abolishes the general annual budgeting and replaces it with budgeting intervals, which are in line with the time horizon of the individual business units. This concept can be seen merely as a work-around and not as a solution of the problem of environmental instability.
2) Rolling Forecasts
The concept of rolling forecasts takes up an idea from production planning: to plan only the next period of time in detail, whereas later periods are planned rather roughly. Furthermore, planning is reviewed in short intervals or even each time when new information becomes available.
Rolling forecasts are a powerful device of coping with an increasingly uncertain environment. However, difficulties arise, as soon as these forecasts are also used to assess individual performance (problem of gaming behaviour).
3) Zero-Based Budgeting (ZBB)
The common practice of constructing budgets incrementally ââ‚¬" by slightly modifying last year's figures ââ‚¬" leads to inflated budgets and therefore, as budgets tend to be spent completely, higher costs. In contrast to this method, ZBB evaluates all spending to determine if they are justified on the basis of direct or indirect value to the customer.
This concept of starting budgeting from scratch has proved very effective in cutting unnecessary costs, but its high costs limit its application largely to a oneoff event.
4) Activity-Based Budgeting (ABB)
ABB is modelled on the concept of activity-based costing. It tries to generate budgets in such way as to hold that manager responsible for the costs of an activity, who has control over the cost drivers.
The idea of this concept is convincing, but as many companies found it even difficult to implement activity-based costing, few took the step to introduce the more complicated system of ABB.
5) Balanced Scorecard (BSC)
The BSC is probably the most comprehensive of the presented tools. It models financial as well as non-financial measures, their connection among one another and their relation to vision and strategy. Furthermore, it emphasis strategic learning and an overall feedback process.
The BSC is an impressively comprehensive and adaptable management tool ââ‚¬"therefore, its great success in the last few years is understandable. But as soon as it is (mis)used as a budget replacement (by performance contracts on certain figures in the BSC), it is subject to the same sort of problems as traditional budgeting (especially gaming and calculated under-estimation of realistic goals) To sum up it can be said that the concepts of Better Budgeting, which are presented above, are suitable to solve certain shortcomings of the traditional budgeting approach.
Yet, they lack coherence and they still accept budgeting and its task as a performance contract and the top-down control system as inevitable.
iii. Beyond Budgeting
Beyond Budgeting does not offer any special methodology; rather it tries to construct a superstructure to the models of the Better Budgeting concept. When concrete implementations are concerned, some of these models (especially rolling forecasting and the balanced scorecard) will be used, but with a modified purpose not to command and control a company, but to support strategic leadership.