The Advantages and Disadvantages of Budgeting

Budgeting as system of organization control sounds not something controversial since even from the smallest organization, one can readily see the need to estimate the level of revenues and expenses and the related amount of assets or resources that may be used to attained a desired. Even from an individual viewpoint, it is normal for a person to know how much he or she is earning from his or job or business as basis of estimated expenses in relation to the kind of life style that a person intends to have.

Living within one’s means is a familiar statement or phrase for those who want to keep a balance of their financial resources and needs.  If this personal principle is applied in business organizations, it should be easy to appreciate the advantages of using budgeting as a system of control.  The idea of control should be kept within the meaning of keeping a balance of the level of expenses in relation to level of revenues. Incidentally, a budget is defined as a formalized quantitative presentation of a firm’s coordinated plans.

Quantitative presentation includes the amounts of estimated, expense, assets and liabilities to be used in the organization. As such, budgeting refers to the act of combining a group related functions or operations of interrelated activities using the revenues, expense, assets and liabilities to attain a particular purpose. The primary purpose of business budgets is to improve planning and control and ultimately to increase profit and improve the financial position of the firm. As such, preparation of formal plan keeps the budget initiated and that is submitted to another person for review. Said budget approximates a ‘contract’ or agreement although not exactly similar to legal contract where one would go to court to enforce performance.

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The employer may just opt to dismiss from employment an ineffective and inefficient manager who simply cannot implement a budget plan. Organizational control is achieved by comparing results with the budget and by holding proper individuals accountable for variances. Results which may be in the form of variances between actual and budget presupposes measurement and measurement is best manifested in the financial report, hence, to do a budget control there must be a system of accounting that allows the verification of  the activity and the corresponding obligation or accountability of the persons in the organisation.

To attain organizational control is to attain the financial and other objectives of organization including the need to demand accountability of managers for results. To appreciate therefore how budgeting helps in meeting objectives, the following subsections will discuss the advantages to be followed by the disadvantages of budgting. Read about advantages of formalization in organization

The Advantage of Budgeting

The advantages of budgeting as system of organization control lie in the capacity of budgeting in ensuring to meet the defined objectives of an organization. Thus, the advantages discussed here are based on the framework on whether budgeting helps in meeting organization objectives.

Budgeting is an important part of planning and is material for the survival of the organization.  Companies are destined to live and to survive in the business world and the keys to success according to the authors  are long term competitive advantage in the knowledge and in the formation economy.   Such keys to successes are based on successful strategic management of intangible resources. It is therefore an issue of how should people especially the managers should spend their time and resources in trying to survive and compete within and outside their organisations. Would they rather forget budgeting and instead concentrate in improving their human resources, training to be more productive without necessarily being tied with their budget system?

 Barsky and Bremser, who aimed in their study to explore the implications of the changes in the global economy on budgeting and performance measurement, did acknowledge that financial budgets have traditionally served as the primary internal metrics of performance. Realizing the pace of accelerating change global economy, the authors felt that it is important for firms to move beyond lagging financial performance indicators to consider variables that contribute to long-term value creation.

Changes in corporate performance evaluation requires new methods. Barsky and Bremser asserted that success of shareholder value could be measured by its ability to maximize the present value of future cash flows to corporate shareholders.  Whatever new method may be used as new term, if it involves the use of estimates of money, the same thing may fall still under the broader concept of budgeting. An interesting question that could be asked is: Is not the concept of present value of future cash flows of corporate shareholders financial management concepts necessarily connected to financial data which the same informational structure as that budgeting?

Of course, there is relationship among financial data. The concept of net present value is indeed part of capital budgeting where estimates of cash flow are made.  Capital budgeting would still not wipe out budgeting, which generically refers to planning.  The authors mentioned about popular ‘economic value added (EVA) which evolved as a measure of management performance’. They did explain that ‘EVA provides a singular measure, adjusted to resolve accrual accounting issues that provide management with an explicit incentive structure that is intended to drive value creation for shareholders’. They cited the work of Amir and Lev which shows that ‘non-financial information is a critical element of the valuation process’ and the proposition that the ‘emerging model for multinational enterprises is the flexible organization. Again the arguments that would seem to deny the use of budgeting is not fully supported hence budgeting as part of planning or breaking the long-term  planning is still relevant in meeting organizational objectives.

Integrated performance measurement systems for greater use of control systems are still budgeting in meaning. Integrated performance systems are deemed part of budgeting. Such  integrated performance measurement systems like the Balanced Score card occupying a great attractiveness, greater use of control systems that report more than financial limits, but also integrate risk, and change being the ‘impetus for substantive employee empowerment in the budgeting and evaluation processes, among others are the main contents of the authors’ recommendation in the study.

The need for tools to help managers in meeting the challenges of strategic implementation and performance measurement would be better served by integrated performance systems. The fact of transfer of global capital from capital-intensive industries to knowledge intensive industries may thus require greater use of control systems. As Barsky and Bremser found that the “shift of resources translates into greater expectations of accountability”. The situation therefore of a more knowledge-based economy would necessitate organisations to empower the managers in the budgeting and evaluation process. This is realisation of the authors that ‘managers across the organizations will be expected to control and monitor greater aspects of the business, in terms of the finance function’ is still arguing for budgeting to be used in organizations.

It may be further argued that hat parties who are clamouring for better techniques point to the different limitations of the traditional budgeting but the concept of integrated performance systems, which include the Balance Scoreboard still, may possess the elements of assigning cost and revenues to profit centres. Such latter activity is essentially budgeting still.

Budgets as mechanisms of efficiency. Wildavsky admitted of conditions before budgeting could be used for planning that is predictability. Predictability is a more of an educated guess rather an improbable forecast. Hence, with its own borders, budgeting may not be compared arbitrarily to what it was not originally intended because simply the conditions for its use did not exist. If indeed budgeting will be used for control and accountability, improvement in terms of efficiency is the necessary consequence.

This fact is confirmed by  Wildavsky’ argument that  ‘budgets may be mechanisms of efficiency-doing whatever is done at least cost, or getting the most out of a given level of expenditure-and/or of effectiveness-achieving certain results in public policy, such as improving healthcare for children or reducing crime.’ It may be argued that to promote efficiency is to reduce cost and to reduce cost is to increase profit and to increase profits is to meet financial objectives.  If efficiency is increased by budgeting, there is should be sufficient ground to believe that budgeting is effective in organizational control.

Budget keeps spending in many organisations whole including the government. It is hard to imagine the absence of budgeting in any organization.   Since the government is an organization, it should be consistent to reason to see the advantage of having budgeting as part of the system.  Without the budgeting in government, it is difficult how would the government organisation regulate and control deficits. There will be a greater evil if there is no budgeting. Viewed from the point of view of a private business, how would such organisations know the limits of their spending for the year without a budget?

 Wildavsky had the opportunity to corroborate this reality when it states that ‘spending by agencies will be kept whole’. He explained that the central budget office bears the brunt or covering larger expenditures and takes the blame when the budget goes out of control, that is, rises faster and in different directions than predicted. He noted that in Britain, where budgeting by volume went under the name of the Public Expenditure Survey, the Treasury finally responded to years of severe inflation by imposing cash limits, otherwise known as the traditional cold-cash budget.

Of course, department cash limits include an amount for price changes, but this is not necessarily, what the Treasury expects so much as what it desires. Wildavsky’s point is that the spending departments have to make up for deficits caused by inflation and that instead of the Treasury handing over the money automatically, as in the volume budget, departments have to request it-and their requests may be denied. He thus advocated that the local spenders rather than the central controllers have to pay the price of monetary instability. In other words, budgeting may be used to control inflation by controlling budget deficits.

The Disadvantages of Budgeting

Budgeting like any other form on control involves cost and there is fear that the level cost may outweigh its intended benefits.   Most organisations have some sort of budgeting system but they are questioning the expense and effort expended against the benefits that the system brings. However, with organizations still using budgeting or some sort of  budgetary system despite their questions indicates a need, is a proof of an indispensable need for budgeting in organization. The problem therefore associated with not being convinced of the benefits of a budget, whether traditional or not, as against its cost is best addressed by the understanding of the need to plan for an organisation. Each model has its own strengths and weaknesses and it is on the decision maker to take advantage of this knowledge about each model’s capabilities and limitations.

A budget historically aims for accountability and control and to have same, there is need for commitment. Unless organisations are willing to let go off this, they may not altogether abandon traditional budgeting.  It is undeniable though that budget systems must go with ever changing environment and technology if companies want to survive competitions in their respective industries. Another disadvantage of budgeting is the it may destroy creativity of some managers as a number of  them may just feel to be bound by what is provided by the budget.  This is of course very much possible if the organization is sticking to a fixed budget.  The remedy therefore is to have a flexible budget.

Conclusion

It can be readily seen that budgeting is here to remain as part of organization because of its advantages outweighing its disadvantages in its function as a system of organizational control. The advantages in using budget in effecting control will remain and would continue to sustain the use of the same as long as there are organizations.  To remove budgeting is to remove planning and to remove planning is to remove management.  Removing management would simply be not acceptable because that would be removing the accountability and purpose of organizations.

This paper has demonstrated the critical role of budgeting as part of strategic management on intangibles in the survival of organizations.  The success of organizations being attributed to new methods do still reinforces the relevance of budgeting in organizational control.  Although the concept of net present value as used cin apital budgeting where estimates of cash flow are made is being praised to have caused success of many organizations, said principles of capital budgeting would still sustain budgeting, which generically refers to planning.

This paper has also established that situation about a more knowledge-based economy that would move organisations to empower management in the budgeting and evaluation process. Since there is the alleged realisation, where managers across the organizations should be controlling   and monitoring greater aspects of the business, in terms of the finance function, the said position in fact is favourable to arguing that budgeting as well should be strengthened.

It was also strongly asserted that  the clamour for better techniques by pointing to the different limitations of the traditional budgeting  and adopt instead the more contemporary  concept of integrated performance systems which include the Balance Scoreboard, could still be considered as arguing for the more expanded use of budgeting. The process as analyzed under such measure of performance still possesses the elements of assigning cost and revenues to profit centres. As such, the latter activity is still essentially budgeting but may be termed in another name. It was also posited that budgeting would promote efficiency.

So that promoting efficiency is aimed to reduce cost. With reduced costs, profits would be increased and the increase profits would undeniably meet organizational financial objectives.  Hence, budgeting is effective in organizational control.  The advantage of budgeting was established indeed even in government organizations as not having budgeting in the government would be denying  government one of its important functions in terms of fiscal policies such as found in regulating and controlling deficits in order to prevent the greater danger of inflation that could have disastrous effects to many business organizations. Thus there would no way to assess the proper tax without budgeting in government.  There were also disadvantages discussed but this paper has provided counter arguments to strengthen the net advantages of having budgeting in organizations as a system of organizational control.

Works Cited

1. American Encyclopaedia, De Luxe Library Edition, Grolier Incorporated,   Connecticut, USA 54.1996
2. Amir B. and Lev B., “Value- relevance of Non- financial in formation: The Wire less Communication Industry,” Journal of Accounting and Economics, 22, 1996, pp. 3-30.
3. Atkinson, Anthony, et al, Management Accounting, Person Custom Publishing, New Jersey, USA, 2005
4. Barsky, P, & Bremser, W.,  Performance Measurement, Budgeting and Strategic Implementation in the Multinational Enterprise, Managerial Finance, Volume 25 Number 2 1999
5. Buckley P. and Casson M. C.,  “Models of the Multinational Enterprise “, Journal of International Business Studies, 29:1, 1998, pp. 21- 44
6. Slavin, S..  Economics , Fourth Edition,  IRWIN, London, UK, 1996
7. Wildavsky, A.,“A budget for All Seasons: Why the traditional Budget Lasts” (1978), The Public Administration Review, vol. 38 (1978):502-
8.  American Encyclopaedia (1996) , De Luxe Library Edition, Grolier Incorporated,   Connecticut, USA, 1996
9.  Barsky, P, & Bremser, W. (1999), Performance Measurement, Budgeting and Strategic Implementation in the Multinational Enterprise, Managerial Finance, Volume 25 Number 2 1999
10. Amir B. and Lev B., (1996) “Value- relevance of Non- financial in formation: The Wire less Communication Industry,” Journal of Accounting and Economics, 22, 1996, pp. 3-30.
11.  Buckley P. and Casson M. C., (1998) “Models of the Multinational Enterprise “, Journal of International Business Studies, 29:1, 1998, pp. 21- 44
12.  Barsky, P, & Bremser, W. (1999), Performance Measurement, Budgeting and Strategic Implementation in the Multinational Enterprise, Managerial Finance, Volume 25 Number 2 1999
13.  Wildavsky, A. (1978), “A budget for All Seasons: Why the traditional Budget Lasts” (1978), The Public Administration Review, vol. 38 (1978):502-509.
14. Slavin, S..  Economics , Fourth Edition,  IRWIN, London, UK, 1996
15. Atkinson, Anthony, et al, Management Accounting, Person Custom Publishing, New Jersey, USA, 2005

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