The Arguments For Abandoning Budgets

2834 words (11 pages) Essay in Finance

23/09/19 Finance Reference this

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The Arguments For Abandoning Budgets And An

Evaluation Of To What Extent Budgeting Is Still A Key

Part In Running A Successful Organisation

Introduction

In this essay I will explore the limitations of traditional budgeting and evaluate the alternative, beyond budgeting. I will look at the potential improvements it can make to a specific business case and the limitations of its general use. I will also look at some alternatives to beyond budgeting including rolling forecasts, bottom up and zero-based budgeting. From this evaluation we will then conclude on the use of budgets in the 21st century and if they are still relevant to the modern-day business.

Beyond Budgeting

Beyond budgeting is defined by the BBRT as follows “Beyond Budgeting is about rethinking how we manage organizations in a post-industrial world which innovative management models represent the only sustainable competitive advantage.” (Budgeting et al., 2014). Hope and Fraser (2003) have been particularly prominent in the promotion of the ideology that traditional budgets are now no longer effective and restrict the ability of companies to respond to change and hence compete effectively in a global marketplace (Dugdale and Lyne, 2006). In practice there seems to be a sliding scale on the implementation of beyond budgeting with some companies fully embracing the approach and disposing of their outdated, ineffective budgets to those that still religiously use them and view them as a key management tool. To understand why moving to beyond budgeting can be positive we first need to understand the limitations of traditional budgeting.

Limitations of Traditional Budgeting

The major assumption of the budgeting process is that past performance is indicative of future performance. This is perhaps also its biggest flaw. By using historical information to predict the future you are therefore ignoring the possibility of change. No matter how frequently the budget is updated there is always the possibility of an unforeseen variance to the trend which hasn’t been planned for. This leaves a business vulnerable and less prepared to adapt to these changes. What makes this even more worrying is the time it takes for the budget to be made. For example, information for a 2018 budget will be gathered half way through 2017 meaning a budget for 2018 could already be wrong before 2018 even arrives and at that point it could become difficult to change, bearing in mind it’s taken 6 months to get this budget ready. It is estimated that budgeting can take up 30% of managers capacity which surely could be better spent running the business in the present (Hope and Fraser, 2003). With the amount of time taken to create budgets the cost is also incredibly high, “A1998 study of global companies showed that on average they invested more than 25,000 person-days per $1 billion of revenue in the planning and performance-measurement processes.” (Hope and Fraser, 2003). Furthermore, budgets ultimately end up being all about the financial output rather than the inputs and processes to achieve them and can end up too general to achieve specific objectives such as improving efficiency where a purchase of machinery may be better served than purely a general reduction in costs (McVay and Cooke, 2006).  Another limitation of a budget is that it mostly focuses on quantitative data and not qualitive data. Businesses and life in general work on a causation basis which can’t be ignored, and most actions can’t be measured. Something such as customer service which can have a causational link to revenue can be measured through surveys etc. but on what basis are these true measures? By receiving more negative feedback does this mean that you service is bad, henceforth receiving less revenue? A business is too complex to make these conclusions and links hence how can a budget truly link them? Overall, the evidence leads me to believe that a budget cannot accurately predict the future. And therefore, leads me to question whether there is a point to budgeting. If we can’t predict the weather a few days from now with certainty how can we accurately predict a business’ performance in a years’ time? These are the problems beyond budgeting tries to alleviate.

Beyond Budgeting in Practice

There are many companies that are starting to realize the limitations of budgets and have moved towards beyond budgeting such as Volvo, SKF, and IKEA (Wallander, 1999). One company that is used a lot in scholarly articles for beyond budgeting is Handelsbanken who adopted the beyond budgeting approach and prospered. The cause behind their prosperity can be debated however it is of the common perception that it is due to the beyond budgeting principle. It was noted that by scrapping the traditional budgets there were no adverse effects on the performance of the bank in line with its competitors who still used the traditional system (Wallander, 1999). And why would there be? Although the budgets have been removed performance is still measured as most benchmarks are still available without the need of a budget (Wallander, 1999). Instead of budgeting the goals of the business are communicated to every employee and the responsibility for achieving them is thus given to the employee (Wallander, 1999). This allows them to achieve the goals in any way they see fit and not in a prescribed manner which allows for innovation and is a key advantage of beyond budgeting. Local managers are given more freedom in decision making which with innovation leads to quicker decisions being made, a vital component in faster paced markets. This extra time allows for a head start on competitors which can be the difference between being a market leader or a follower. Not only is there extra time given from quicker decision making there is considerably more time from not having to prepare the budget. This then allows managers to be more involved in the day to day running of the business and ready to react and adapt to present change again giving a head start on competitors (Wallander, 1999). In an article by Jeremy Hope and Robin Fraser it was noted that “Some project leaders estimate that they have saved 95% of the time that used to be spent on budgeting and forecasting.” (Hope and Fraser, 2003). This can equivocate to almost 68 days based on the average time to create a budget being 10.3 weeks (Uyar, 2009). By removing budgets, you are adapting your targets from an absolute sum such as £’s to a more general target such as increasing profit, reducing costs, or improving sales. This can allow for greater accountability on an employee level as the goals will inherently be more understandable and hence be easier to achieve. Also, from decentralizing some internal systems may no longer be required which can have a great effect on a company’s cost structure (Hope and Fraser, 2003). Although not noted in Handelsbanken’s case implementing beyond budgeting allows the removal of window dressing as there is no exact figure they are trying to reach due to more general goals (Uyar, 2009). This helps give a more accurate view of the business and higher quality information.

Criticism of Beyond Budgeting

One key criticism in the case of Handelsbanken is the type of business it is. The business was able to decentralize relatively easily and suited the decentralized model. For businesses that are more reliant on other internal functions it would be a lot harder to decentralize and the accountability of each employee may be a lot harder to understand. Essentially It is proposed that abandoning budgets suits businesses that can be easily segmented and place little reliance on central functions and that Budgets should be used for the coordination of business units where outputs of one relate to the outputs of another (Dugdale and Lyne, 2006). Take for example the R&D sector within a business, not using a budget could lead to excessive spending with little economical gain. This then shows the other main use of budgets which is the control it gives. By using generalized goals such as those in beyond budgeting such as to increase revenue it can ignore the implications of added cost and hence potentially worse profitability. In a survey by Dugdale and Lyne all companies said that budgets were important for control, co-ordination, and communication which is vital for companies that rely on itself (Dugdale and Lyne, 2006). This proves even more true for a business that has slim margins where without planning could lead to losses. It could also be demotivating for employees in the business if they must rely on other sectors of the business that don’t deliver as it makes it much harder for them to have an impact on the overall goals of the business. Especially for those in departments that are cost centers such as IT. There is no easy way for the IT department to impact on the sales for the business which if the goal is to improve sales there is little motivation to do so. Another key limitation of beyond budgeting is that by decentralizing and empowering more employees you have a higher risk of a poor decision being made by someone who may not have the experience to make the call. This would then leave other sectors at a higher risk. Hence it could be argued that for decentralization to take place you need the correct skills and if not, you may have to hire or train individuals to meet the roles which could be costly. It could also lead to a duplication of roles between sectors which may be better served by one person.

Is It All About Beyond Budgeting?

If anything, I think it is easier to argue that beyond budgeting isn’t the key influencer in an increase in performance that some of these companies have seen but is more down to the knock-on effects of beyond budgeting. The main one being the increase in motivation of the workforce. By decentralizing the structure of the company and giving more responsibility to the workers they are improving motivation in line with Herzberg’s 2 factor theorem (Herzberg, 1964). Not only from increasing responsibility but by increasing accountability which inevitably increases perceived recognition. Also, by reducing the number of strict rules and encouraging a more innovative environment it starts to change the rules from a hygiene factor to a motivator. By executives divulging power to managers the employee can feel that their opinion matters which is fitting with Elton Mayo’s motivational theories. This improvement in motivation and increase in responsibility will no doubt increase the performance of the company as there is a lower likelihood of “freeloaders”. Essentially by increasing everyone’s responsibilities in achieving the company goals they are implementing a sort of total quality management. This would fit with a perceived increase in performance as people are less likely to make a mistake as they are more accountable hence the costs behind these mistakes will reduce and as people are more motivated from their increased responsibility they are less likely to leave reducing employee turnover and hence reducing the cost of hiring and training new staff.

Better Budgeting

There are positives and negatives to beyond budgeting and to the traditional budgeting process, but which one is better? I believe that there should be more of a balance in a business as only in certain cases is one best. Rather than scrapping budgeting I believe the process should be improved. This view is common in Finland where 61% of companies who responded to the survey said they would like to improve their budgeting system rather than remove it all together (Ekholm and Wallin, 2000). A similar question was asked to Canadian business’s where 46% indicated they would make changes to their process within 2 years (Libby and Lindsay, 2010). In the same paper the changes were to do a more bottom up approach and use rolling forecasts. The bottom up approach is more of a middle ground between conventional budgeting and beyond budgeting as it decentralizes the process and includes lower levels which could have the motivational benefits of beyond budgeting in Handelsbanken’s case. Rolling forecasts also aim to bridge the gap more by reducing by using fewer measurements and doing more frequently as they save a lot of time compared to traditional budgeting and will help reduce the risk of out of date budgets enabling greater flexibility in market changes (Hope and Fraser, 2003). Another form of better budgeting could be zero based budgeting which helps alleviate the problem of relying on historical data as it is as if it is written from day one. This then helps to reduce the slack built up over time and can allow large capital expenditures which may better impact the business (Neely et al). It could be argued that a combination of these methods could give the same benefits of beyond budgeting without eliminating budgeting altogether.

Conclusion

The question asks to what extent is budgeting is still a key part of running a successful organization and I think the true answer is that it depends on the business you are applying it to. In the Handelsbanken case their business suited being split into smaller divisions and working as a decentralized structure however not all businesses are like this. A business that relies on its internal functions may not be able to implement an effective beyond budgeting approach and should look towards a more traditional or better budgeting method. Another factor is the market the company is operating in. If the company is based in a fast paced ever changing market a beyond budgeting approach may prove beneficial to keep ahead of competitors and keep on top of customers’ needs and wants however for a business who is in a less competitive slower market with little change a traditional budget may be just as effective as it is inherently easier to predict. Ultimately, I believe traditional budgeting is starting to become outdated, clunky, and expensive and we are finally starting to see a reduction in unnecessary information which the advent of computers dawned on us. We are starting to move into the evolution of traditional to better budgeting which uses less information but gives better information with greater utility. At this stage in time I believe it is too soon for most companies to abandon budgets completely and that better budgeting is the compromise until more trust is built up in the extremist beyond budgeting principle. It is no surprise there is a reluctance to change as the traditional methodology has been around for the past 100 years but moving into a post-industrialization age and with new methods being created the next 100 years will be much different.

References

  • Budgeting, W., Institute?, W., membership, B., principles, T., Team, T., Team, T., Bogsnes, B., Olesen, A., Larsson, D., Röösli, F., Morlidge, S., Founders, T., services, A., Books, B., Books, O., Articles, W., Resources, H., Papers, W., Resources, F., Budgeting, M. and Base, B. (2014). What is Beyond Budgeting? Here you have the answer. [online] Beyond Budgeting Institute. Available at: https://bbrt.org/what-is-beyond-budgeting/ [Accessed 31 Jul. 2018].
  • Dugdale, D. and Lyne, S. (2006). Technical Matters: Budgeting. Financial Management, pp.32-35.
  • Ekholm, B. and Wallin, J. (2000). Is the annual budget really dead?. European Accounting Review, 9(4), pp.519-539.
  • Herzberg, F. (1964). The Motivation-Hygiene Concept and Problems of Manpower. Personnel Administration, 27(1), pp.3-7.
  • Hope, J. and Fraser, R. (2003). Who Needs Budgets?. Harvard Business Review, [online] 81-2, pp.108-115. Available at: http://web.a.ebscohost.com.ezproxye.bham.ac.uk/ehost/detail/detail?vid=0&sid=b169ffa7-03ed-4cb3-b640-21d5bc07b815%40sessionmgr4009&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ%3d%3d#AN=9018347&db=buh [Accessed 31 Jul. 2018].
  • Libby, T. and Lindsay, R. (2010). Beyond budgeting or budgeting reconsidered? A survey of North-American budgeting practice. Management Accounting Research, 21(1), pp.56-75.
  • McVay, G. and Cooke, D. (2006). Beyond budgeting in an IDS: the Park Nicollet experience. Healthcare financial management, [online] 60(10), pp.100-110. Available at: http://web.a.ebscohost.com.ezproxye.bham.ac.uk/ehost/detail/detail?vid=0&sid=8216de79-16f3-4bd3-9167-baec119044c6%40sessionmgr4010&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ%3d%3d#AN=22901171&db=buh [Accessed 31 Jul. 2018].
  • Uyar, A. (2009). An Evaluation of Budgeting Approaches: Traditional Budgeting, Better Budgeting, and Beyond Budgeting. Journal of Academic Studies, 11, pp.113-130.
  • Wallander, J. (1999). Budgeting — an unnecessary evil. Scandinavian Journal of Management, 15(4), pp.405-421.

 

 

 

 

 

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