Replacing Traditional Budgeting with Alternative Performance Measurement Systems

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Replacing Traditional Budgeting with Alternative Performance Measurement Systems

Traditional Budgeting and its Weaknesses

When preparing a traditional budget one makes a list of all planned revenues and expenses. Such a budget focuses on what is to be spent rather than what resources a person has. A traditional-based budget focuses on what the organization is allowed to spend rather than the resources they need, to bring profit in their business. This budget aims to achieve maximum allocation of resources that other budgeting systems fail to do. Most organizations use the traditional budget system, as it is easy to prepare. However, some people feel that such a budget has incorrect records since they are too long or too short, they depend on unsuitable formulas, they can be manipulated easily, they can also be too complicated, and they cannot be modified (Preparing a Budget p14). Usually such a budget does not identify waste, future incoming business, does not allow continuous development and does not identify cost drivers. This goes to show that traditional budgeting is not connected to the organizational strategy as the expenditure predicted maybe either too high or too low. A traditional budget does not address fundamental concerns. Organizations that use such a budget should change and adopt a budget that focuses more on their work policies and channel their revenues to those activities (Marcino 3)

Traditional based budgets can be manipulated easily by employees who know the system. This form of budget tends to put a lot of pressure on employees who incur costs on items that were not in the budget. This form of budget centers on goals based on the increase from previous times, and in this case, the organization does not consider its shareholders and customers (Stokdyk J. 2007). A traditional budget is a top down approach whereby the top management are the once who set the parameters. This move can create dislike to the lower level staff as it sets unrealistic targets for them and they may view the budget as overbearing. It also has advantages as it shows what is expected of all employees in the organization and is an effective communication tool for performance. A traditional-based budget keeps the employees focused, and it helps compare progress of their key performance areas (Principles of accounting 7).

Performance Measurement Systems

Traditional financial reporting systems give an indication of how an organization has performed in the past but does not give information about future performance. The Balanced Scorecard performance measurement system considers financial measures, customers, business process and learning measures. This gives employers a balanced view of the organizational performance. It is used as one of the method for calculated planning and management styles. (Balanced Scorecard Institute). The Economic Value Added estimate is a performance measurement that is used by the organization in order to estimate its profits. EVA is the profit made by an organization less the expenses from the organization’s capital. This form of system helps the organization identify whether they are making profits. This form of performance measurement limits the company to only one single financial period (Harper 12).

New Budgeting Methods

An activity-based budget (ABB) is one that presents a budget in terms of costs associated with an organizations objective – products and services other than cost. While using an activity based budget organizations are able to analyze profits made from their products effectively. Organizations that use this budget have better communication of planned goals and allow maximum usage of resources. One noteworthy aspect of this budget is that it can look at the results and activities that make the company, unlike a cost based budget. This helps the organization to have a more accurate financial forecast than when using other systems. The ABB budget shows the firms’ details of operating cost as it shows value adding actions and their prices (Small Business Accounting Guide 4).

Zero Based Budget (ZBB) is a system whereby every function is analyzed for its cost and purpose. Based on this information then a budget for what is needed in the future regardless of whether the budget is less or more than from the previous time. This budget has it advantages as it an efficient allocation of resources as it is based on needs and benefits other than history. Although it takes time to come up with such a budget, it makes the employees find a more cost effective way to improve production. This budget makes staff motivated and makes them responsible for the decisions they have made. It also gives an indication on where resources are being wasted.

Strengths of New Budgeting Systems

Majority of firms chose to retain a formal budget because it only limits expenditures but an organization can predict income, profits, and returns of the year to come. It gives the organization control, and they can be able to determine how they will share profits and bonuses. Budgetary processes have to be done carefully as the same principles used can give negative results (Newcomer 91).

Large organizations retain a formal budget, as each department is accountable for their contribution to the organization. This makes budgetary process a collective process for everyone in the firm to show how they plan to accomplish their goals the year ahead. All departments prepare their goals and targets and the top management reviews them for approval. The top management reviews at the proposed budgetary plans if adopted then it becomes the road map to for the new fiscal year. Quarterly and monthly reviews are done to see if the budget is being followed and how each department is performing (Behn 11). The most significant benefit of a formal budget is that it ensures every department head reviews their monthly and quarterly performance thinking about their operations. This gives them a clear demonstration of future opportunities and hindrances. A formal budget creates a detailed picture and information guides them in their day-to-day work. However, this budgeting system is time consuming, and in some companies, the process of budgeting prevents the head of departments from doing their work as it ties them for several weeks (Marcino 34)

Challenges in New Budgeting Systems

Uncertainty in the economy affects a formal budget and may render it futile and counterproductive. A formal budget has been criticized for threatening trust, empowerment, and slowing down innovation (Drunker 1992). Businesses that are starting and small and medium size organizations budgets are easy to plan but as the business grows, the owner needs to have a formal budget for his business. If the owner can keep a formal budget as the business grows, he will avoid a budgetary system that does not support growth, creativity and adjustments. Such an organization needs a formal budget that allows them to plan events, predict the future and handle expenditure (Bunce 21).

Value Added by New Budgeting Systems

A formal budget assists in planning and predicting the future. As most managers are busy with their duties, a formal budget assists them to identify the crisis before it occurs. This reduces distractions because they take care of the problem before it occurs, thus reducing corrective measures. A formal budget also helps a company in putting money where most returns and profits will be generated. It also helps the employees become aware of shortage of income. A formal budget is crucial as it helps a company monitor performance that can be compared against budget resources. This allows the organization to know whether they are meeting their targets. (Robert 1997). Most organizations still maintain the formal form of budgeting as they can predict the future of the organization and direct its focus on income generating areas.

Works Cited

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Bunce, Dr. Peter, “Transforming Financial Planning in Small and Medium Sized Companies.” Beyond Budgeting Round Table, 2007.

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Marcino, George. “Obliterate Traditional Budgeting – Most Budgeting Doesn’t Address Fundamental Issues. Consultant Marcino Says Organizations Should Consider Activity-Based Planning to Understand Their Work Processes, Value Them and Then Fund Them.” Financial Executive: Fe. 2000. Print.

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Robinson, Marc, and Duncan Last. A Basic Model of Performance-Based Budgeting. Washington, D.C: International Monetary Fund, Fiscal Affairs Dept, 2009. Web. November 28, 2011.

Small Business Accounting Guide. (n.d). Web. November 28, 2011.

Stokdyk J. Traditional Budgeting under the microscope. 2007. Web. November 28, 2011

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