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

  Topic B Managing Financial Resources  

Table of contents

  List of tables  I

1  Introduction  1

2  The purpose of traditional budgeting  2

3  in a highly competitive environment  4

4  Budgetary control and its disadvantages  6

5  Is the traditional budget really out of kilter with competitive environment?  7

6  Summary  9

7  Conclusion  9

  References  II

  List of tables  

Table 1  : Alternative budgeting models  4

  Sven Roehm  I

Topic B Managing Financial Resources

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 fastchanging 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.

Sven Roehm 1

Topic B Managing Financial Resources

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.

Sven Roehm 2