Budgeting: Approaches and shortcomings

2

  Plan  

  Introduction  3

Chapter I.  The Nature of Budgeting And Its Functions  4

1.1.  Definition of Budgeting  4

1.2.  Requirements to Budgeting  6

1.2.1.  Integrity of Budget Allowances  6

1.2.2.  Strategic Adherence of Budget Allowances  7

1.2.3.  Prevention From Opportunistic Behavior  7

1.2.4.  Flexibility  7

1.2.5.  Economic Efficiency  7

Chapter II.  Classical Budgeting  8

2.1.  Brief Description of Classical Budgeting  8

2.2.  Performance Profile of Classical Budgeting  9

2.2.1.  The Reach of Budgeting Process  9

2.2.2.  Alignment With Strategy  10

2.2.3.  The Threat of Misuse  11

2.2.4.  Flexibility  11

2.2.5.  Economic Efficiency of Classical Budgeting  12

2.3.  Appropriateness  12

Chapter III.  Zero-Base Budgeting  14

3.1.  The Concept of Zero-Base Budgeting  14

3.2.  Performance Profile of Zero-Base Budgeting  15

3.2.1.  Integrity of budget allowances  15

3.2.2.  Strategic Adherence of ZBB  15

3.2.3.  Prevention From Opportunistic Behavior  16

3.2.4.  Flexibility  16

3.2.5.  Efficiency of ZBB  17

3.3.  Appropriateness  17

  Conclusions  19

  List of literature  20

3

Introduction

The present paper purposes to highlight two most well known approaches to budgeting, specifically classical and zero-base budgeting. In last years there is much criticism blaming shortcomings of the both. However, such treatment seems to be biased without deep penetration in the nature of budgeting systems. The paper does not intend to summarise information about approaches to budgeting, but rather to explore system specific features that bring the shortcomings about.

The paper is composed in the way not to contrast the approaches, that is to show the superiority of one of them, but to draw a profile of the approach with respect to selected criteria. The criteria, introduced in the first chapter, reflect major requirements to the budgeting systems from managerial point of view. They encompass integrity of budget allowances, adherence to strategy, impact on employees’ behaviour, flexibility and efficiency. Owing to scarce capacity the paper omits aspects specific to management and organization but still affecting the performance of the budgeting approaches. These are, for example, organization of planning process (bottom-up, top-down, etc), corporate culture, incentive structure, degree of activity formalization, management style, etc.

The second and third chapter discuss instantaneously performance of classical and zero-base budgeting respectively. Analysis begins with brief description of most important features of the approaches and concentrates extensively on how respective approach meets the requirements. Finally, there will be discussed the most suitable type of production which makes up in part for disclosed shortcomings.

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Chapter I. The Nature of Budgeting And Its Functions

1.1. Definition of Budgeting

Budgeting belongs undoubtedly to the most wide spread financial coordination tools of management. Despite this fact there is no unanimity among theorists about definition and functions of budgeting ¹ . The clear contrast one can observe between American and German concepts of budgeting resulting from different approaches to controlling. Anglo-Saxon point of view regards budgeting mostly as a tool for financial planning, thus as a subject to financial department activities: “A budget may be considered to be a set of financial statements resulting from a particular scenario- generally the most likely or hoped for scenario. A budget therefore reflects management opinions regarding future financial circumstances” ² . This synonymic treatment of budget and financial plan was adopted from governance practice of public corporate bodies where budgeting embraces comparison of income and outlay entries.

The German doctrine considers budgeting more likely as planning conducted on all management levels and for different time perspectives: “Ein Budget ist für uns ein formalzielorientierter, in wertmäßigen Größen formulierter Plan, der einer Entscheidungseinheit für eine bestimmte Zeitperiode mit einem bestimmten Verbindlichkeitsgrad vorgegeben wird…Unter Budgetierung wollen wir den gesamten Budgetierungsprozess verstehen, d.h. insbesondere Aufstellung, Verabschiedung, Kontrolle sowie Abweichungsanalyse” ³ .

For the purpose of this paper we will depart from the following budget features:

¹ Cp.: Horváth (2004), pp. 68.

² Altman (1986), pp. 17.

³ Horvath (2001), p. 233.

The role or the aim of budgeting is to govern decision units and departments in the organization towards its goals ⁵ . Generally, one distinguishes following functions of budgeting:

- Motivation. By means of performance measurement, evaluation, and remuneration budgeting should direct managers toward company’s goals. This function aims to solve or at least to mitigate the problem of information asymmetry. Personal benefits conditioned to objectives, often expressed in financial form, and participation of subordinates in planning process supplies enough incentives for a man on site not to shirk, but to act on behalf of the firm.

- Coordination. Owing to the overall planning character of budgeting, it facilitates management to overcome difficulties of recourse, profit, and risk interdependencies. Using vertical and horizontal reconcilement enables you to reveal possible bottlenecks and problems as well as counteract erroneous tendencies.

- Communication. For the purpose of effective management subordinates should have sufficient information about organizational goals in order to adjust their actions appropriately. On the other hand, superiors need to be up to date about strategy progress. Budgeting, because of planning procedures suffices this function at least formal.

Budgeting is embedded, in most cases, in overall planning process. It seems to be expedient to highlight the most characteristic features of the process. The reconcilement of department budgets figures is the most time consuming procedure ⁶ . The anticipation of coherent company wide performance disposes management to eliminate as many discrepancies as possible in the start-up phase, that is a year ahead.

⁴ See: Pfaff (2002), pp. 232.

⁵ Cp. Ibidem, p. 233.

⁶ Cp. Horvath (2001), p.247 et sqq.

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The next constitutive step embraces supervision of budget progress and current is-tobe comparison, and analysis. As a rule, monthly figures are summarized by managers in charge in form of standardized reports, which have to be submitted to the superior instance. Discovered in this way insufficient executive affords will be corrected by means of either positive, or negative sanctions.

Over the budgeting period, normally a year, companies revise budgeting allowances. If planning office assesses initial premises and assumptions inadequate or erroneous, the costly budgeting procedure will be initiated and target figures will be adjusted.

1.2. Requirements to Budgeting

For the purpose of further analysis, it is necessary to elucidate requirements to budgeting as a company-wide coordination tool. Dilger, in his comprehensive research of budgeting systems, suggests that budgeting has to suffice at least two basic criteria ⁷ , specifically to take into account the aspect of optimal performance as well as satisfaction of employee. Despite the first one overlap to certain extent the above-mentioned coordination and information function, it seems to be necessary to precise the requirements.

1.2.1. Integrity of Budget Allowances

In present paper, budget consists of two parts: activity program and execution budget. The former prescribes the sorts and actions amount with possible end product figures need to be done in a cost centre. The latter defines resources entrusted to manager in charge to realize preset targets. In practice, these parts are integrated in one document with listed activities and the cost threshold in each entry. Such a matrix form of a budget allowances secures goals adherent behaviour of responsible officials. Determination of activity program alleviates supervision of performance and impedes the temptation on the side of person in charge to neglect some of his functions, i.e. activities in order to meet the budget. Thus, here should be analysed how far such control is possible within particular budgeting system.

⁷ Cp. Dilger (1991), p 102.