Turkish Tax News
17 May 2017Erdal AYDIN

The Usefulness of Traditional Budgeting in Today’s Business Environment


Technology and the rapidly changing conditions of the modern world force companies to review their management and budget systems. In order to maintain a sustainable company, company management must optimize available financial resources via controlling and planning.

One of the most widely used management tool for controlling and planning is budgeting. Its purpose is to generate a system for performance evaluation and increase the motivation of all employees by enhancing coordination and communication between subsections of companies (Horngren et al., 2005).

However, the usefulness of traditional budgeting has become controversial. Opponents of traditional budgeting advocate that new budgeting approaches such as ‘better budgeting’ or 'beyond budgeting’ should replace traditional budgeting.

Traditional budgeting is analysed in this study; firstly, with respect to its advantages and weaknesses. Secondly, alternative approaches to traditional budgeting are introduced. Thirdly, the influences of organisational culture on budgeting is discussed. Finally, the utility of traditional budgeting in today’s environment is presented.

2. Traditional Budgeting
2.1. Traditional Budgeting and Its Advantages

A traditional budget can be described as a quantitative statement and complementary tool for an action plan. It usually includes goals relating to cash flows, expenditures, revenues, assets, and liabilities for a specific period (Dropkin et al., 2007; Horngren et al., 2012). A traditional budget is prepared by adding incremental amounts, such as inflation or planned increases in sales prices and costs, to current annual budget (ACCA, 2014; Wildavsky, 1978).

Traditional budgeting is mostly performed with a top-down approach as a result of a hierarchical mentality. This means, central management prepares a former budget according to company’s strategy for all departments and then sub-departments elaborate budgets according to their needs (Rothberg, 2011).

Proponents of traditional budgeting advocate that traditional budgeting is important for value-creation and the sustainability of companies. It boasts advantages such as controlling the company; forecasting and planning the future; improving coordination, communication, and motivation; and facilitating performance reviews and price decisions (Joshi et al., 2003; Oak and Schmidgall, 2009). The ‘big picture’ advantages of a good traditional budget and its links with shareholder value-creation are presented below:

2.2. Weaknesses of Traditional Budgeting

Although its benefits are known and widespread usage all around the world, some companies are dissatisfied with weaknesses of traditional budgeting practices (Ekholm and Wallin, 2000; Hofstede, 1967; Onsi, 1973; Merchant, 1985; Lukka 1988). A research alleges that 80% of the companies are not pleased with their budgeting and planning procedures (Neely et al., 2003).

In literature, main criticisms for traditional budgeting are about time-consuming and budgetary gaming. Moreover, Neely et al. (2003) identify twelve weaknesses of traditional budgeting in three categories from the literature, as follows:

Table-1  Weaknesses of Traditional Budgeting

  • Budgets are rarely strategically focused and often contradictory
  • Budgets concentrate on cost reduction and not on value creation
  • Budgets constrain responsiveness and flexibility, and are often a barrier to change
  • Budgets add little value, they tend to be bureaucratic and discourage creative thinking.
  • Budgets are time consuming and costly to put together
  • Budgets are developed and updated too infrequently-usually annually
  • Budgets are based on unsupported assumptions and guesswork
  • Budgets encourage gaming and dysfunctional behaviour
  • Budgets strengthen vertical command and control
  • Budgets do not reflect the emerging network structures that organizations are adopting
  • Budgets reinforce departmental barriers rather than encourage knowledge sharing
  • Budgets make people feel undervalued.

Source: (Neely et al., 2003; p.23)

As regards time-consuming, Neely et al. (2003) allege that the budgeting process takes 20% of managers’ time. As for budgetary gaming, Libby and Lindsay (2010) reveal that commonly used budget gaming methods including spending all budgeted money remaining (instead of losing it), determining easier targets to generate budgeting slack, and taking a big bath.

Taking a big bath means that if companies have big losses in current year, managers transfer current year’s revenues to following year or following year’s costs to current year. Thereby, reaching next year’s targets gets easier. Following figure demonstrates that above mentioned budget gaming weaknesses occurs occasionally:

3. Alternative Approaches to Traditional Budgeting

In order to eliminate weaknesses of traditional budgeting, two main alternative approaches are established as ‘better budgeting’ and ‘beyond budgeting’. Better budgeting focuses on enhancing the budgeting process and solving the problems of traditional budgeting. As for beyond budgeting, it brings radical changes to the budgeting process and focuses on performance measurement problems of traditional budgeting.

3.1. Better Budgeting Approach
3.1.1. Activity-Based Budgeting

Activity-Based Budgeting bases on activity framework, which uses cost drivers in budgeting and it aims perpetual progression in costs and performance. Linking cost of resources and outputs by considering activities makes Activity-Based Budgeting more advantageous than traditional budgeting (Brimson and Fraser, 1991; Cooper et al., 1992; Maddox, 1999).

3.1.2. Balanced Scorecard

Balanced Scorecard is a four-dimensional approach to performance measurement and management (Otley, 1999). Unlike traditional budgeting, it balances financial and non-financial information (Banovic, 2005). The schematic view for Balanced Scorecard method can be seen below:

3.1.3. Zero-Base Budgeting

Zero-Base Budgeting designs a completely new budget as though company does not have any history. Zero-Base Budgeting is advantageous because it compels budget setters to analyse every item and managers to search for alternatives, thus reducing budget slack and wastefulness and allocating resources depending upon results and necessities (Pyhrr, 1976).

3.1.4. Value-Based Management

Value-Based Management refers the notion that all expenditures should aim to increase shareholder value. It enables shareholder value to be considered in budgeting and planning processes (IMA, 1997).

3.1.5. Profit Planning

Profit Planning’s purpose is to evaluate if organisations or sub-units generate economic value, create enough cash, and attract enough financing for investments in order to plan profit centres’ financial cash flows (Neely et al., 2003).

3.1.6. Rolling Budgets

Rolling Budget is a plan which is perpetually updated, thereby the timeframe remains constant while the actual term covered by traditional budget varies (Hansen, 2011; Horngren et al., 2012). Advantageously, a Rolling Budget forces managers to reconsider processes and make adjustments every term or month. The difference between a Rolling Budget and traditional budgeting is figured as follows:

3.2. Beyond Budgeting Approach

Hope and Fraser (2003a) describe beyond budgeting as a series of leading principles which enables the decentralisation of companies’ decision-making mechanisms, and manage their performance free from traditional budgets. Beyond budgeting has three main objectives: implementing an adaptive management mentality in changing conditions, a high level of decentralisation to organisations (CIMA, 2007), and performance measurements based upon relative performance contracts with hindsight to prevent dysfunctional management behaviours (Hansen et al., 2003).

Differences between the ‘beyond budgeting’ approach and ‘traditional budgeting’ are outlined by Jeremy Hope as in Table-2:

Beyond budgeting’s radical principles are performed in some companies and the results are introduced in different studies. For instance, Mitchell (2005) analyses six North American finance companies and Rickards (2006) analyses Unilever and German Railways. The most influential study in the literature is Svenska Handelsbanken (Swedish company), which has been using ‘beyond budgeting’ more than 40 years. Wallander (2003) claims that the main influence of Handelsbanken’s success is its decentralized structure. Ahlsell (another Swedish company) also performs beyond budgeting with its over 200 decentralised centres (Hope and Fraser, 2003b).

Hope and Fraser (2003a) claim that if companies perform principles of beyond budgeting well, then unlike with traditional budgeting, they can reach two peaks as being adaptive and decentralised organisations which is shown on following figure:

4. Influences of Organisational Culture

Organizational culture is the sum of the values and behaviours within an organisation (Needle, 2004). The main determinants of an organisation’s culture are its country’s culture (Hofstede, 1980; Ueno and Sekaran, 1992) and its sector (Leung et al., 2005). Furthermore, the organisational culture itself directly affects management mentality, budgeting practice, and the success of budgeting practice in an organisation. ‘Traditional’, ‘better’, and ‘beyond’ budgeting exhibit different characteristics, and each can be successful in a different type of organisational culture.

Hofstede (1980) asserts four dimensions of countries’-societies’ cultures. These dimensions of countries’ cultures transmit their characteristics into organisational culture and management mentality, which affect organisations’ success with various budgeting practices, as follows:

Power distance refers to the hierarchical structure of organisations. If an organisation has a high level of hierarchy, managers tend to favour traditional budgeting for its command-control and top-down mentalities. Here, beyond budgeting cannot be successful in this organisation due to its requirements for decentralization. Individualism-collectivism indicates the communication and coordination level of organisations. Highly collectivist organisations can perform beyond budgeting better than traditional budgeting due to their teamwork and information-sharing mentality.

Uncertainty avoidance relates the ability to overcome adversity to the uncertainty of the future. If employees can overcome uncertainty stress-free, then beyond budgeting may better suit such organisations with rapidly changing environments. Masculinity-Femininity indicates whether male or female is dominant in society. If any gender is dominant in an organisation, this organisation might be inclined to use traditional budgeting due to its inegalitarian perspective.

Sectors of organisations, as the second determinant, affect managements’ mentality and the success of budgeting practices. If an organisation does business in a rapidly changing environment, beyond budgeting may suit the organisation better due to the method’s adaptive structure. However, if an organisation runs in a stable sector with stable customer demands, technology, and environment, traditional budgeting may be successful.

Svenska Handelsbanken (a bank) and Ahlsell (a wholesaler), which both practise beyond budgeting successfully, are perfect examples of sectors’ and countries’ impacts on organisational culture. Both have changing business environments and both do business in Scandinavia with their accountable, decentralised and information-sharing cultures. Hammer (2010) claims Scandinavian culture has low power distance, weak uncertainty avoidance and strong collectivism. It is understood that Scandinavian culture and its influences on companies create an environment in which to perform beyond budgeting successfully.

On the other hand, different surveys demonstrate that traditional budgeting is yet more successful in Europe (Kennedy and Dugdale, 1999; Dugdale and Lyne, 2006). The main reason for this result is that most of the observed companies have similar organisational cultures due to being in relatively stable business sectors within the same territory. All of the above studies illustrate that organisational culture is of a great importance to management mentality and budgeting practices.

5. How Useful is Traditional Budgeting in Today’s Business Environment?

Traditional budgeting is still popular as a planning, performance management and control tool (Ahmad et al., 2003; Libby and Lindsay, 2010). Many directors believe they can manage, control, communicate and coordinate subsections better via traditional budgets without sharing authority with company subsections (Dugdale and Lyne, 2006). In reality, many organisations’ cultures and management mentalities do indeed suit traditional budgeting.

The focus for these organisations is how they can eliminate the weaknesses of traditional budgeting. Libby and Lindsay (2010) advocate many successful companies eliminate their weaknesses by performing different budgeting approaches together. Furthermore, as mentioned in part 2.1., general expectations from budgeting have pivoted towards value-creation in today’s business environment.

Therefore, companies should improve their budgeting practices by considering value-creation, rapidly changing environment, their own culture and requirements. They can do it by utilising traditional budgeting with different budgeting approaches. This perspective means that traditional budgeting remains relevant for many companies in today’s business environment.

6. Conclusion

Traditional budgeting is still popular and it has innumerable different practices. Even if the adaptive characteristics of beyond budgeting sound better, many companies’ cultures, natures of business and management mentalities are not yet suitable for modern budgeting strategies. Therefore, despite its weaknesses, traditional budgeting maintains its importance as a planning, performance measurement and control tool of management.
By focusing on rapidly changing environments and value-creation, companies can improve their budgeting practices by implementing traditional budgeting together with other budgeting approaches. This perspective is more beneficial than merely abandoning traditional budgets. The important point is companies must understand their own requirements, conditions, culture and weaknesses before improving their traditional budgeting practises. Consequently, traditional budgeting is still useful today for many companies when combined with other budgeting approaches.

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