Effectiveness of Budgetary Control in the Changing Business Environment

1645 words (7 pages) Essay in Finance

08/02/20 Finance Reference this

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Introduction

 It is not a secret that the business environment and the way firms operate have changed a lot in the last few decades. Such as retail industry have had more and more competitors come into the market and new technology processes established. There is much more volatility in today’s world, meanwhile, that incurs questions. When the change is so rapid whether the budgetary control processes will be effective for corporations or should they be abandoned. This essay will analyse the effectiveness of the budgetary control in this rapidly changing environment.

Background

 The twenty-first century is characterised by a complex and unpredictable environment. The advantage is that information technology encourages firms to enter the industry with better products and cheaper ways of doing simple business. This also brings a new way for companies to manage their systems online. New laws were published that requires changes in how companies operate such as the minimum wage, health requirement and individual insurance. However, the customers become more and more fickle to the products also banks and investors started to lose their interests in financing the industry due to the unsteady financial environment. For instance, in 2008 the financial crisis, thousands of banks collapsed including the famous bank Lehman Brothers even they are “too big to fall”; in 2016 after the Brexit vote, the exchange rate of the British pound fell dramatically, even now Brexit’s unfinished business still influences the financial environment; in 2018 the trade war between China and America resulted in HUAWEI, TCL and ALIBABA three big Chinese corporates closed their firms in the USA, which lead to lots of Americans to lose their jobs. The business environment in the world now is more unsteady and complicated than before, therefore, it will be much harder for people to forecast future tendency and make their plans forward. The approaches to set the long-term plans and targets for companies may also be influenced by this circumstance, such as the budgetary control process may show its limits in this unforeseeable situation.

Budgetary control is useless in unpredictable environment

 Budgetary control is harmful to the company’s overall profit under the tense circumstance. If the companies want to stand out in the market after the financial crisis, they must work as a team and work towards the same goals. However, according to Jensen (2001), corporate budgeting is a joke, under this more intense market situation, it encourages the managers to lie and cheat. Managers set their targets lower than the normal level and the actual results will be easier to exceed, then they can get rewards from the executives. “It distorts incentives, motivating the employees to act in the ways that run counter to the best interests of their companies” Jensen (2001, p.94). Consider these two examples, in an international manufactory, the managers set their sales budgets for next month, they send the unfinished components from England to the warehouse in China for final assembling and sell to customers, by shipping the incomplete products the managers were able to know the sales revenue before the end of next month and thus fulfil their budget goal and achieve their bonuses. Nevertheless, the cost of transporting the unfinished products and the rental fees of the warehouse in China, under the trading war between America and China circumstance it will also incur additional costs and losses thus reduce the overall profits of the company. According to Jensen (2001), the same thing happened to a beverage company in real life. The vice president of sales for one of the company’s largest regions remarkably underestimate the demand for a coming holiday. His intention is simple, he wanted to set the revenue target lower then he could definitely exceed it. But the price for his lie is extremely high, the company produced the beverage based on the demand and consequently ran out of its main products in the largest market at the height of the holiday selling season. If this happened after the financial crisis then this company lost a good chance to boom their profits. Such distorted decisions are common in business; people can easily find it in most companies. Unfortunately, this shenanigan has become so common and unavoidable for companies, the budgeting process is deeply involved in company’s life, these lies and games are accepted as business as usual (Jensen, 2001). Even in the steady environment it cannot be prevented and cause huge loss, not to mention in the unpredictable and complicated situation.

 Budgetary control is too rigid to change with today’s competitive environment. As the essay discussed above, in the age of big events coming up, and the fickle customers everywhere, companies should be flexible to the market and readjust their strategies according to the new market environment. However, few companies can plan forward with any confidence. Hope and Fraser (2000, p. 30) indicated that “most organisations remain locked into a ‘plan-make-sell’ business model that involves a protracted annual budgeting process based on negotiated targets and resources and that assumes that customers will buy what the company decides to make”. Nevertheless, these assumptions no longer work nowadays, on the one hand, today’s customers are hard to be satisfied, they want advanced, fashionable and cheap products, which is more difficult targets for companies to achieve, particularly for companies just recovered from the financial crisis and suffered from Brexit or the trade war again. On the other hand, in some extreme cases, use budgeting to force performance improvements, this may lead to the breakdown in the company’s ethics, represented by Hope and Fraser (2003). The WorldCom, now bankrupt and under criminal investigation, one of the employees said everyone had a budget, and the executive always mandates employees should act 2% lower than the budget. CEO’s rigid demands were overwhelming for those employees. “Refer to an article in Financial Times last year. ‘Nothing else was acceptable.’ WorldCom, Enron, Barings Bank, and other failed companies had tight budgetary control processes that funnelled information only to those with a ‘need to know’” Hope and Fraser (2003, p.108). In the budget process, when the managers perceived they were evaluated in a very rigid budgetary style, which was more likely to experience the job-related pressures thus work less effectively.

Budgetary control is still useful

 However, Libby, T. and Lindsay, M. R. (2009) indicated that most companies still intend to hold onto the annual budgeting or may be adjusted to meet the new demands.

 Budgetary control plays an important part in helping an organisation’s survival in this increasingly competitive environment. As what said in the theory, the budgeting control process uses an integrated system to help bring together the activities from different parts and specialised functions of the business to help the company to achieve the targets. Meanwhile, it provides the mechanism for managers to measure the performance and to adjust the budgeting level to be more appropriate for the company. Especially since the computer technology is being used in firms, it will be much easier for companies to get through the budgeting information and send the feedback quicker to the manager thus make the budgetary control more efficient (Fisher,1989). According to Libby, T and Lindsay, M. R. (2009) for the companies that use budgetary control process, 94% companies indicated they were not planning to abandon it but maybe do some adjustments on it. For instance, a bottom-up orientation and gather more information from front-line managers, using rolling forecast to make the process more accurate and prepare less detailed budgets initially and update them regularly using ongoing forecast. From the research, most companies agree that the problems with the budgetary control are more related to how companies use it, the process has more potential if it is being used appropriately (Libby, T and Lindsay, M. R. 2009).

Conclusion

 Even most companies will still use the budgetary control but most of them agree to do some adjustments, that indicates the budgeting process for control purpose does have some limitations in the new environment. To sum up, this essay agrees that budgetary control system should be abandoned in this rapidly changing environment. This system is not flexible to this complex market, it will make managers feel more intense and pressure thus not effective enough to achieve the corporate’s goals also it is hard to make employees work towards the corporate’s goal hence the overall profit of the company will be reduced. As the time passes by, the budgetary control will show more and more drawbacks, like the telephone is replaced by mobile phone and the mobile phone is replaced by the smartphone, only evolution and development can survive in this fast-changing environment.

References

  • Hope, J. and Fraser, R. (2000) Beyond Budgeting, Strategic Finance, 82(4),October,
  • pp. 30-35.
  • Hope, J. and Fraser, R. (2003) Who needs budgets? Harvard Business Review, 81(2), February, pp. 108-115.
  • Jensen, M. (2001) Corporate Budgeting is Bad-Let’s Fix It, Harvard Business Review, 79(10), November, pp. 94-101.
  • Fisher, G.I. (1989) A study of the effectiveness of budgetary control in medium-sized firms, (1st ed.), London: Technical and Research Department of the Chartered Association of Certified Accountants,
  • Ekohlm, B. and Wallin, J. (2000) Is annual budgeting really dead? European accounting review, 9(4), pp. 519-539.
  • Libby, T. and Lindsay, M. R. (2009) Beyond budgeting or budgeting reconsider? A survey of North-American budgeting practice, Management Accounting Research, 21(1), November, pp. 56-75.
  • Hopewood, G.A. (1972) “The relationship between accounting and personnel management — past conflicts and future potential”, Personnel Review,1(2), October, pp.40-47.
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