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The economic downturn has made last year's budgets mostly irrelevant. Managers in businesses make decisions that impact the profitability of the business. In order for these decisions to be successful, organizations must plan and coordinate effectively. According to CIMA official terminology (2005), a budget is a quantitative plan that spans a specific period of time. While traditional budgeting has played a significant role over the years, research suggests it may not be as suitable for modern businesses. This essay aims to explain the concept of budgeting, its purpose, different types of budgeting, the definition and pros and cons of annual budgets, as well as rolling budgets.
Budgeting has several important functions.
The main goal of budgeting is to predict and project future financial results.
Various budgeting methods exist, such as incremental budgeting, zero-based budgeting, priority-based budgeting, and rolling budgeting. While these methods share similarities in the preparation process, each has its own set of pros and cons.
Incremental budgeting, also referred to as traditional or annual budgeting, is a technique based on past and actual results.
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It involves making adjustments for known changes and inflation (CIMA official terminology, 2005) and is used as the foundation for creating budgets by incrementally adding amounts to existing budget periods. The simplicity of incremental budgeting makes it easy to comprehend and execute.
Incremental budgeting is advantageous for several reasons. It is simple and easy to prepare, and it aligns with the line of authority and responsibility within the organizational unit.
This method can be applied to organizations of all sizes due to its flexibility. One of its main benefits is that it is simpler than zero-based budgeting (ZBB) or rolling budgeting (Drury, 2009). It saves time and energy and provides a better understanding that is well-received by government board members and legislators (Smart, 2004).
Incremental budgeting is criticized for its failure to meet today’s business demands, as it cannot adapt to the new competitive environment. This leads to fixed and inefficient costs for non-unit level activities, wasteful spending, and difficulty in maintaining the main concept of budgeting. Outdated budgets result when they do not align with past activity levels. The lack of incentives in this budgeting method, which relies on yearly percentage increases, also fails to consider changes in a company's priorities from previous budgets, leading to disappointment (Drury, 2009).
Incremental budgeting issues have led to the development of new budgeting methods like rolling budgeting. Rolling budgeting is defined as a continuously updated budget, extending into the next accounting period (month or quarter) as the current period expires. This approach is particularly useful when future costs or activities cannot be accurately forecasted. Rolling budgeting is advantageous because it permits frequent budget updates in response to deficits caused by economic fluctuations.
Rolling budget is regularly reassessed, making it more realistic and accurate than annual budgeting. This helps lessen the uncertainty associated with rolling budgets as they are revised regularly, making them very useful in times of increasing inflation. Planning and controlling are based on recent and updated plans, as rolling budgets are continuously extended several months ahead. Rolling budgeting is appropriate for large organizations like Texaco, Volvo, and Bulmer, as it takes economic changes into consideration (Drury, 2008). Despite its advantages, rolling budgets also have disadvantages. It is time-consuming and costly, requiring multiple budgets to be produced throughout the year. The amount of work involved in each budget reassessment can be overwhelming for managers.
Revising budgets may necessitate adjusting standards or valuations, which can be time-consuming. Zero-based budgeting is a method that requires all costs to be justified based on expected goods, aiming to eliminate inefficiencies, reduce waste, and prioritize value for money. While this process can be time-intensive and require management to develop new skills, it ultimately focuses attention on efficiency (CIMA official terminology, 2005; Drury, 2008). Priority-based budgeting involves budget requests accompanied by a statement detailing the anticipated changes if the prior period's budget is increased or decreased by a certain amount or percentage. This type of budgeting is particularly suitable for non-profit organizations facing challenges with long-term strategic planning and resource allocation.
The criticism of budgeting and beyond budgeting is that budgets can be time-consuming, expensive, and fail to focus on shareholder values. They may prevent quick responses, be too rigid, and prioritize sales targets over customer satisfaction. This can lead to unethical behavior such as padding the budget. The Beyond Budgeting Round Table (BBRT) argues that traditional budgeting is not only inflexible and inefficient but also contributed to corporate scandals like Enron and WorldCom (Hope and Fraser, 2003; BBRT et al, 2007 cited in Stokdyk J. et al, 2006).
Research has shown that despite criticism, both financial and non-financial managers and companies continue to use budgets because they are seen as important for planning, controlling, performance measurement, communication, and coordination. Traditional budgeting has advantages over other types of budgeting, such as zero-based and rolling budgeting, because it is cost-effective and simpler to implement. Unlike rolling budgeting, which requires regular updates and can be time-consuming, incremental budgeting is done annually, making it a less complex option. Although rolling budgeting may be more accurate due to regular updates, it may not be suitable for all organizations. However, in cases where there is greater demand volatility, companies may consider adopting rolling budgeting.
To sum up, budgeting offers the benefit of predicting future financial performance, although it can be time-consuming and costly. Incremental budgeting is straightforward and suitable for all types of organizations. However, it may struggle to meet the demands of a changing competitive landscape. On the other hand, rolling budgeting is regularly reassessed, making it more accurate than annual budgeting. Nonetheless, it is also time-consuming and expensive due to the need for multiple budgets throughout the year.
The Role of Budgeting in Modern Businesses. (2016, Dec 21). Retrieved from https://studymoose.com/what-is-budgeting-essay
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