The Traditional Budgeting Process

The Traditional Budgeting Process 1

THE TRADITIONAL BUDGETING PROCESS

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Introduction:

Financial budgeting planning is a process that has been in use to estimate the revenues

and anticipate expenditures over a long period. Very many multinational companies have

adopted the budgeting process and made them an integral part of their planning processes and

operations since its inception in the 1920’s. The ability of budgets to allocate and coordinate

efficient use of resources through in-house communication and simultaneously controlling

expenditure evaluation and authorization has made budgets a most popular tool for

administrators and the management of companies to rely on. The popularity of the budgeting

process has seen the technique remain unchanged in its use since its initial introduction into the

business world. However, in its continued use over time, some managers have noticed some

severe dysfunctional tendencies exhibited by the budgeting process.

Hope and Fraser (2003) argue that the traditional way of budgeting has gone “Out of

Favor” with Organizations’ competitive business environment. Various other critics have echoed

the disparagement towards traditional methods of the budgeting process terming it as “an

unnecessary evil (Wallander 1999, Cited in Rohm 2007 p, 7). Others have developed popular

phrases to disapprove of the traditional budgeting process, such as “The yearly Budget is Dead”

(Gurton 1999, Cited in Rohm 2007 p, 7). The undesired negative tendencies demonstrated by the

budgeting process have prompted various scholars to try to come up with ways and solutions to

counter the adverse effects identified by financial managers such as budget gaming, budgeting

bias and budget slacking among other issues. Several different contingency policies and theories

have been established, and indirect and direct connections between employee motivations,

business environment and budgets have been examined.

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According to Hope and Fraser (1999a), huge American and European multinational

companies have resolved to alternative methods and dismantled the budget. Increasing

theoretical discussions have had effects on companies approach towards the traditional budgeting

process. For example, research has shown that some Scandinavian organizations have recently

started to adapt to new forms of strategic, operational and budgeting control process (Glader

1996, Cited in Rohm 2007 p, 10).Rolling predictions and forecasts are vital in future planning

because they are quick to respond to shocks caused by unforeseen external factors. Hope and

Fraser (2003b) state that only about 20% of companies alter their budgets within the economic

year. The inflexibility attributed to strict adherence to budgetary planning is non-competitive in

the current economic business market. Business analysts recommend rolling forecasts as an

effective tool for controlling and observing changes in the short term.

The Traditional Budgeting Process:

In his award-winning book called ‘Winning’, the chairperson for General Electric

Company Limited Jack Welch (2014) states that the budgeting process is one of the most

ineffective practices in organizational management. He continues to say that budgeting slurps the

time, energy, big dreams and fun out of a company. Most budgets are detrimental to a company’s

road map to success. Most European company executives have shared in Jack Welch’s dislike

for the traditional budgeting process. In light of this, they have slowly but surely adapted to

rolling forecasts and other modernized methods of unceasing financial planning. In the recent

past, more and more American business organizations are slowly shifting sides to the new ways

of financial adaptive planning.

There are countless research reports that have been submitted on the issues of traditional

budgeting by BBRT (Beyond Budgeting Round Table), an organization that is based in the

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Northern part of America. The organization has concluded that budgeting poses great blockade

to transformation because of the extensive work. In one of its report, BBRT reports that on

average, a regular organization devotes about three and a half months and about 30% of financial

managers and senior executives’ time to the budgeting process. Some organizations are

reportedly said to spend up to nine months in the budgeting process. Hacket Group (2003)

discovered that a typical multinational company in the million-dollar category earners wasted as

many as over 20,000 person-days per billion dollars of earnings summing up the yearly budget.

The Northern America regional director for Beyond Budgeting Round Table Company

explains that the once significantly important instruments of control, budgets have become

hazardous tools in today’s markets for global buyers and knowledge/information economy.

Additionally, Budgets prevent flexible and fast market adaptation so that companies and

organizations realize only a fraction of their potential. Budgets also often encourage deception,

mistrust and endangerment to organizations transparency (Butz 2011).

Budgetary Problems:

Many organizations tie employee and executive rewards directly to performance against

budgetary estimations and projections. This has been a common practice among organizations

especially those that were formed before the first global depression. When this happens,

employees aspire to bring down the performance expectations to suit achievable target levels.

Therefore, employees are engaged with the management in discussions of possibly bringing

down the budgetary estimated targets to achievable budgetary levels. For instance, for persons

mandated with operating a revenue-generating department, it is more likely for them to try to

reduce the estimated target, to look good after having exceeded the expectation.

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Conversely, a manager responsible for managing a cost center will try to maximize on

spending, regardless of whether the expenditure is necessary or not. From an incentive point of

view, persons advocating for a larger expenditure pocket will look good, and the same cycle

continues. The resultant effects of budgetary discussions with staff are that the budget becomes a

continuous mediation with the organizations management, and rather than representing the real

picture at the ground, ends up being an arbitrary and fictitious document.

Budgeting process costs too much, uses a lot of business capital and takes an elongated

time to be fully completed. Depending on how big a company is, the budgeting process can take

up to ten months of planning (Libby and Lindsay, n.d.). Most companies on a calendar financial

period begin planning for the budget in the summer, ending the process in late October and

sometimes December, or even in some instances, finishing the budgetary process after the

commencement of the budget period. The budget process is tedious and time consuming with

back and forth discussions involving many different stakeholders, which only compounds to the

total sum of organizations resources used up in the budget process. In other cases, the employees

and the management become entangled in internal politics usually associated with budget

allocations. These sideshows usually overshadow the customers’ demands and expectations

leading to poor quality service.

Budgets are inflexible, fixed, and often irrelevant. The traditional budget is a detailed

process that involves proposals of detailed information from the lowest staff members to the

management and right to the board regardless of any alterations that may need immediate action

taken to correct a dire situation. Once the budget has been approved, there are no more changes

that can be effected. The market conditions may change, or even the economic elements may

need some changes done to suit the current market. New regulations may be introduced;

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unforeseen competition may enter into the market, new partnerships may emerge, new concepts

or technology may necessitate a quick reaction from the company. Budgets are also perceived to

strengthen the obstructions and barriers between sections and departments rather than boost

sharing of knowledge. Budget estimations are also said to be short-term financial estimations in

nature, and they tend to ignore important shareholder interests.

A survey done by the BBRT and APQC on forecasting, planning and budgeting

discovered that about 55% of respondents claimed that the statistics applied in their research

were altered and never represented the actual situation on ground, making them irrelevant within

the first five months of the financial year. A leading researcher in that exercise noted that there is

a tendency for budgets to differ as the situation at the ground tends to become unstable due to the

accelerating nature of business markets. BBRT is cautious to clarify that Beyond Budgeting does

not involve new techniques or tools. They explain that it is an administrative philosophy founded

on a set of defining principles made from actual cases resulting to adaptive management

performance (Hope & Fraser 2003).

Rolling Budgets and Forecasts:

Continued existence in an environment that is highly competitive means that corporate

organizations must be innovative and flexible through the innovation and development of

different services and products. Nevertheless, integrating the effects of product improvement and

innovation into the traditional budgetary process can be a daunting task, especially if

organizations have fixed budgets that are time specific. Budget reviews may be done from time

to time depending on a company’s policy; however, the basic budget remains unchanged during

the course of the financial year. In light of the above, many organizations have resulted to adapt

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to rolling budgets and forecasts as a means to counter the rigidity of traditional budgets (Hayes

2002).

A continuous budget also commonly referred to as a rolling budget is a financial planning

tool that is updated continuously so that the allocated period of planning remains unchanged,

while the actual period that is covered within the budget varies (Hope & Fraser 2005). For

instance, as each quarter passes, the one-year continuous budget is prolonged by one quarter, so

that there is always an annual budget in place. This results to an up-to-date, accurate and cost

effective budget, integrating all the current data. In a continuous budget, information is routinely

updated to include current information reflecting varying market trends, business or industry

conditions. Rolling budgets are regarded to offer best present-day estimations as to the

company’s operational and financial performance over a certain period.

Rolling budgets are updated continuously rather than semi-annually or quarterly. This

implies that they are therefore more precise and need little amounts of time to be updated as

compared to traditional budgetary planning model. In a traditional budgetary model, planning for

a new budget starts afresh and involves the process of marshaling up resources from the

grassroots. Rolling budgets on the other hand involves minimal modification s as the budgets are

regularly updated. It is through this process that lot of time and physical, human and financial

resources are saved.

Whereas the traditional budgetary system ties down the management and staff performance to

the budget, the rolling budgets provide an environment for competition to thrive.

Companies in a rolling budget have some degree of freedom to adjust to suit market

inconsistencies and changes. The management can focus on achieving high returns and results by

putting their attention on outdoing competition. For instance, an organization can employ main

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industry metrics to estimate its performance against market leaders in the industry, and using

those results to benchmark and re-adjust current performance to suit market trends.

Figure 1: Major differences between New Beyond Budgeting Model and Traditional Budgeting

Source: Who Needs Budgets (2003).

Traditional Budgeting

Management Model

Rolling Budgets and Forecasts

Management Model

Targets and Rewards

Incremental Targets, Fixed

Incentives

Stretch Goals, Relative

Targets and rewards.

Planning and Controls

Fixed Annual Plans, Variance

Controls

Continuous Planning KPI’s

and rolling forecasts

Resource and Coordination

Pre-allocated resources,

Central Coordination

Resources on demand,

Dynamic coordination

Organizational Culture

Central Control, Focus on

Managing numbers

Local Control of goals and

plans, Focus on value creation.

Application of the Continuous budgets in the Private Sector:

In the Private Sector, this method can be most favorable because the focus shifts from

internal competition to beating other managers and competitors in the market. With such a

setting, companies automatically adjust to the winning formulae by focusing all their energies to

beating the competition. Rolling budgets also acts as a motivator, challenging staff members

while providing clear guidelines and responsibilities. The reward system within the

organizational structure of rolling budgets focuses on teams and not individuals. This again,

motivates staff members to come up with winning ideas, placing the market standards as the

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benchmark. In conclusion, rolling budgets allows managers and the executive to make rational

decisions, removing unnecessary spending that put pressure on resources.

The rolling Budgeting method is suggested for organizations and companies that are

undergoing radical transformation, companies who are very young in the industry, organizations

that are experiencing quick growth trends, where realized results are significantly different from

the planned amounts (Libby and Lindsay, n.d.). Emphasis of rolling budgets should be placed on

vital variables such as costs, sales, orders, cash flows and profits because these variables are

significantly important for companies and should be uninterruptedly observed.

Response to Change:

Many European corporations have initiated the idea of shifting away from the traditional

way of budgeting. European markets tend to be less regulated, thus promoting a favorable market

for growth and development. Likewise, in the United States, markets have a short-term mentality

because of the effects of quarterly reporting on earnings, a common feature influenced by the

Wall Street. Companies are therefore, involuntarily pressed to stick to the traditional way of

budgeting, which is watched closely by Wall Street, creating little room for any flexibility. As a

result of this, many corporations have been defiant on any changes towards a more flexible way

of budgeting.

However, in the current past, there has been willingness by some customers to try out

rolling forecasts, with a few of them adapting to the new budgeting style, while still maintaining

the traditional budgeting system. The ultimate objective is that in due course, the concept of the

stop-and –start and the calendar year will become insignificant.

The goal is that in due course the concept of the calendar year and the stop-and-start budget will

become less and insignificant.

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Workscited:

BOGSNES, B. (2009). Implementing beyond budgeting: unlocking the performance potential.

Hoboken, N.J., John Wiley & Sons.

BUTZ, C. (2011). Role and Effects of Budgeting in Managerial Practice. Mnchen, GRIN

Verlag GmbH. http://nbn-resolving.de/urn:nbn:de:101:1-20110815378.

HACKETT GROUP (FIRME). (2003). The book of numbers. Hudson, Ohio, The Hackett Group.

HAYES, J. (2002). The theory and practice of change management. Houndmills, Basingstoke,

Hampshire, Palgrave.

HOPE, J., & FRASER, R. (1999). Beyond budgeting ...: breaking through the barrier to 'the

third wave'.

HOPE, J., & FRASER, R. (2003). Who needs budgets? Boston, Mass, Harvard Business School

Pub.

HOPE, J., & FRASER, R. (2005). Beyond budgeting: how managers can break free from the

annual performance trap. Boston, Mass, Harvard Business School Press.

Libby, T. and Lindsay, M. (n.d.). Beyond Budgeting or Budgeting Reconsidered? A

Comprehensive Survey of North American Managers' Views. SSRN Journal.

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ROHM, S. (2007). Are traditional budgeting practices out of kilter with companies' competitive

environment. Mnchen, GRIN Verlag GmbH. http://nbn-resolving.de/urn:nbn:de:101:1-

2010081310999.

WELCH, J., & WELCH, S. (2014). Winning the ultimate business how-to book. [S.l.],

HarperCollins e-Books. http://rbdigital.oneclickdigital.com.

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