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Are traditional budgeting practices out of kilter with companies' competitive environment

Essay 2004 13 Pages

Business economics - Controlling

Excerpt

Table of contents

List of tables

1 Introduction

2 The purpose of traditional budgeting

3 in a highly competitive environment

4 Budgetary control and its disadvantages

5 Is the traditional budget really out of kilter with competitive environment?

6 Summary

7 Conclusion

References

List of tables

Table 1: Alternative budgeting models

1 Introduction

Hope and Fraser (2002) argue that traditional budgeting is “out of kilter with [companies’] competitive environment”. Indeed, traditional budgeting has faced harsh criticism in the recent years. Eye-catching titles, e.g. ‘The budget - an unnecessary evil’ (Wallander, 1999), ‘Bye, bye budget - the annual budget is dead’ (Gurton, 1999), and ‘Take it away’ (Hope and Fraser, 1999b) show the “anti”- traditional budgeting campaign led by some critics.

According to Hope and Fraser (1999a), some big European and American companies have dismantled the budget or are about to do so. It seems that the theoretical debate increasingly changes the companies’ attitudes towards the traditional budgeting. Especially some Scandinavian companies head for new forms of operational and strategic control means, e.g. balanced scorecards. About 40 per cent of Swedish companies stated in a survey that they already work on changes to the budgeting process (Glader et al., 1996). Above all, rolling forecasts should play a more important role in the future, raising the responsiveness to changing external factors. According to Hope and Fraser (2003) only 20 per cent of organisations change their budget within the fiscal year. This rigidity is not up-to-date to the fast- changing competitive economy. Therefore rolling forecasts could be more effective for observing and controlling short-term changes.

This paper will primarily deal with the criticism on traditional budgeting, especially in relation to Hope and Fraser’s assertion. Furthermore, this paper examines whether there is an impact of the above noted campaign on economy, and companies increasingly abandon its budgeting systems due to the criticisms.

2 The purpose of traditional budgeting…

“A budget is a plan expressed in monetary terms covering a future time period (typically a year broken down into months)” (Collier, 2003: 207). Budgets list estimated sales, i.e. market demand or capacity limit, and the estimated revenues opposed by all caused costs for usually one year. The budget is closely linked with the strategy, allocating resources due to strategic targets and plans (Collier, 2003).

Furthermore, budgeting ensures that the actual financial results are in line with the targets, broken down to the responsibility centres, e.g. business units or departments. Therefore budgeting is a management tool for controlling the responsibility centres and the costs they are causing . It also serves to overview the interrelationship between different responsibility centres, to motivate the managers to achieve their targets and accordingly to evaluate the managerial performance (Collier, 2003).

The traditional budgeting system was fit for the producer-dominated markets after World War II, when demand of the population for nearly product was high and the competition comparatively low. It effectively controlled internal costs and productivity, because external influences could be neglected. Since this situation changed in the 1960s and 1970s and companies increasingly have had to deal with stronger competition and more ‘unreliable’ customers, the traditional budgeting faces harsh critic. It is unable to cope with external changes and changing customer demand because it only carries forward past values which are only adjusted by growth of sales and price increases (Scheld, 2000). That means that budgets can spread excessively, and carry forward inefficiencies without any revise.

Accordingly, Peemöller (1997: 164) warns “Die Budgetierung darf nicht Wiederholung eines alljährlichen Rituals werden” (“Budgeting may not become an annual repetition of a ritual”).

Some of the companies have a ‘flexible’ traditional budgeting system which only flexes the budget due to variances in sales. However, it does not allow a broader look on eve ntually changed cost structures; so does a company’s action to react on external or internal changes (e.g. Marketing or PR expenditures) cause more sales- independent overhead costs (Collier, 2003). Consequently, the traditional budget is not really able to cope with external changes that are due to the generally raising competition in markets.

Therefore, new budgeting models, as illustrated in table 1, were created in order to eliminate the weaknesses of the traditional budgeting system. But these approaches also have had weaknesses and disadvantages as shown in table 1, and thus a majority of companies have stick more or less to the traditional budget.

Alternative budgeting models

Zero base budgeting Activity-based budgeting Kaizen costing (budgeting) As a response to the weak-nesses of traditional budgeting, zero-base budgeting has gained popularity in the 1960s and 1970s, and it is still predominant in a majority of organisations. In contrast to the traditional budgeting, zero-base budgeting refuses any carry- forward actions by allocating resources according to their justification in terms of necessary actions to achieve the agreed targets and margins (Scheld, 2000). Collier (2003: 208) argues that it is “very difficult to develop a budget while ignoring current resource allocations”. More than that, zero-base budgeting is very time-consuming and costly because every responsibility centre must be involved in the budgeting process. With regard to the high time-consumption of zero-base budgeting, forecasts might be out of date even before the budgeting process has finished (Scheld, 2000).

The third form of budgeting is the so-called activity-based budgeting (ABB). Different from the other forms, ABB identifies cost drivers in activities. The advantage is that costs can be allocated more thoroughly to its producers. ABB develops budgets which forecast the expected amount of activities to meet the sales projections (Collier, 2003). A major disadvantage of ABB is the high time-consumption for identifying the cost drivers, and that the cost drivers are very susceptible to changes of the system, e.g. product or service modification, outsourcing.

Kaizen is the Japanese term for continuous improvement (Collier, 2003). According to Scheld (2000), kaizen costing complements the traditional budgeting by analysing and optimising continuously business processes instead of merely controlling cost centres. Kaizen costing differs from the ABB approach by integrating the whole staff into the continuous improvement process, in contrast to the rigid planning purpose of ABB. The improvement actions will be added to the budget, even when they are not favourable for the organisation in short-term. Therefore, kaizen costing is supposed to overcome the inflexibility of the annual budgets.

Abbildung in dieser Leseprobe nicht enthalten

Table 1: Alternative budgeting models

3 …in a highly competitive environment

Moreover, the highly competitive environment of companies and the increasing confidence of the consumers nowadays make exact assumptions about the demand more difficult. There are more variances in demand than in the producer-dominated markets few decades ago. However, budgets focus on sales rather than customer satisfaction (Hope and Fraser, 2003). But there are no sales without customers, and the customers become more and more demanding and selective. If the company is not able to deviate from the budget in order to react on customer trends and needs, it soon will not have anything to budget - no customers, no profit, no budget, and therefore no future! But not every company and every product is positioned in an equally competitive market. There are companies with niche products which face hardly any competition; hence demand is rather predictable. These companies can rely on traditional budgeting as a mean of internal cost control, because missing competition can lead to a resource-wasting corporate culture.

Wallander (1999) contradicts, even if there was economic stability and the business continues as usual, budgeting would always be based on previous experiences. Therefore, people would continue in the way they have worked before, independent from a budget. Additionally, unpredictable challenges on the business cannot be coped by budgets because “we have no ability to foresee something of which we have no previous experience” (Wallander, 1999: 411).

It is nearly undoubted - even from “conservative” organisations defending the traditional budgeting - that the traditional budgeting is not a suitable system for signalling cha nges in the environment and solely steering and controlling a company nowadays (Ekholm and Wallin, 2000). Hardly any company can put through an annual budget without any revise during one year. But these revisions are time- consuming, costly, and finite, i.e. while the budget will be modified or changed, the changes are out of date and thus have to be changed endlessly. An applicable example is buying a computer; after you have paid it at the check-out of your retailer, it is out of date and you need a newer one . Accordingly the budget is not applicable to operational decisions, and therefore it “provides poor value to users” (Hope and Fraser, 2003).

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Details

Pages
13
Year
2004
ISBN (eBook)
9783638273312
ISBN (Book)
9783638759977
File size
399 KB
Language
English
Catalog Number
v24457
Institution / College
University of Teesside – Tesside Business School
Grade
80% äquivalent zu 1,0 (A)
Tags
Managing Financial Resources

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Title: Are traditional budgeting practices out of kilter with companies' competitive environment