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Thursday, September 5, 2019

Budgeting as a Performance Management Technique

Budgeting as a Performance Management Technique â€Å"Financial measures are inadequate for guiding and evaluating organisations’ trajectories through competitive environments.† Kaplan and Norton (1996: 24) In the introductory quotation, Kaplan and Norton, in their call for a balanced performance management scorecard employing financial, customer, internal business process, and learning and growth perspectives, cite one reason why finances, including budgeting, are increasingly ineffective when used to the exclusion of other factors. The Beyond Budgeting Round Table (â€Å"BBRT – Beyond Budgeting Round Table† 2007: n.p.), self-described as â€Å"an independent, international research collaborative†, and others have identified additional drawbacks associated with focusing on budgeting as a performance management tool. This essay begins by identifying and discussing those drawbacks then continues with a discussion and evaluation of a proposed solution proposed by the BBRT. Over the past two decades the pace of competitive change has been occurring at an ever-increasing rate, but the budgetary processes of many organisations have not changed (Coombs 2005: 34). Coombs suggests that traditional budgetary processes add little value because they limit an organisation’s ability to react to environmental changes. Increasing numbers of organisations recognise this problem as indicated by expressions of dissatisfaction with existing budgeting processes (Fraser 2001: n.p.). Fraser claims that, as organisations realise the diminished value of budgeting in performance management, they are acknowledging the increasing costs of, and time required by, the current budgeting process. Parmenter (2003: n.p.) claims that increasing numbers of organisations in Europe, Asia, New Zealand, and the United States believe that the budget is a hindrance to management. Fraser (2000: n.p.) contends that the budgeting process, as part of the conventional performance improveme nt model, is too rigid to respond to rapid changes in today’s economy. In â€Å"About Beyond Budgeting – The Budgeting Problem†, the BBRT (2007: n.p.) identifies and describes problems with the traditional budgeting process. These problems are associated with budget management time and cost, user value, shareholder value, flexibility, business costs, product and strategy innovation, focus, relationship to strategy, culture, and ethics: Budgeting Time and Cost. The budgeting process is time consuming. Estimates of time consumed are as high as five months for each cycle, occupying 20 to 30 percent of financial managers’ and senior managers’ time. As an example of the cost of the traditional budgeting process, Ford Motor Company calculated the annual cost of its budgeting at US $1.2 billion. User Value. Although the budgeting process provides an element of control to some managers, the people who actually use budget information realise little value. For instance, almost 80 percent of finance staff time is spent on lower value activities with the small remainder devoted to higher-order activities such as financial analysis. Shareholder Value. Budgets concentrate on internal targets, which are heavily influenced by prior period budget results, rather than focusing on maximising value to customers and shareholders. Flexibility. Budgets are often too inflexible to support quick responses to changing environmental factors. Only one-fifth of all organisations change their budgets within the related fiscal period. Business Costs. Not fully spending budgeted amounts is discouraged in many organisations leading to a failure to adequately question budgetary requests. In this way, unnecessary business costs are protected rather than reduced. Product and Strategy Innovation. Traditional budgetary practices discourage risk taking because emerging opportunities are too often not reflected in current period budgets. Focus. The focus of budgets is frequently on sales goals instead of customer satisfaction. Although most organisations recognise the importance of customer satisfaction, individuals are often not rewarded on this factor; rather, they are rewarded on achieving sales targets. Relationship to Strategy. Budgets are often â€Å"divorced† from strategic decisions due to the poor support that budgets provide to organisational strategy. Culture. Traditional budgeting creates and maintains dependency cultures in organisations because people are deemed successful when they strictly adhere to budget figures. Ethics. The high importance of meeting budgetary goals may cause people to behave unethically, even fraudulently. Fortunately, there is an alternative to the traditional budget model. Coombs (2005: 34) suggests that this alternative should create and support a â€Å"performance climate†. The alternative should empower managers and encourage entrepreneurship throughout the organisation; should be externally-, rather than internally-, focused; and should provide an environment that promotes individual motivation. Claiming that it is â€Å"at the heart of a new movement searching for ways to build lean, adaptive and ethical enterprises that can sustain superior competitive performance†, the BBRT has developed a solution to increase the effectiveness of performance management in the twenty-first century (Fraser 2001: n.p.). Two concepts underlie the BBRT solution (â€Å"About Beyond Budgeting – Concepts† 2007: n.p.): adaptive processes and devolved networks. The BBRT recommends replacing fixed budgets with adaptive processes incorporating ambitious, regularly reviewed targets based on benchmarks, peer goals, and previous fiscal period results. The BBRT also recommends replacing centralised decision-making and performance accountability with devolved networks, which are achieved through decentralisation, to increase productivity, motivation, and customer service. The BBRT’s concepts of adaptive processes and devolved networks each embody six principles (â€Å"About Beyond Budgeting – The Principles† 2007: n.p.). Adaptive process principles include: (1) formulating goals based on maximising performance potential, (2) evaluating and rewarding based on contracts for relative improvement, (3) conducting action planning in a continuous and inclusive manner, (4) ensuring resource availability, (5) coordinating actions across the organisation based on customer demand, and (6) basing management controls on effective governance and ranges of performance indicators. Devolved network principles include: (1) instituting a governance framework with clear principles and boundaries, (2) establishing a high-performance climate, (3) delegating decision-making authority, (4) assigning decision-making responsibility commensurate with authority, (5) expecting accountability for customer results, and (6) creating information systems that supp ort ethical behaviour. The inadequacy of traditional budgeting as a performance management tool, considering the ever-increasing pace of environmental change faced by most organisations, is well supported by research conducted by the BBRT and others. The concepts and principles offered by the BBRT seem solid if somewhat limited in scope in that the BBRT, in heavily focusing on budgeting, does not furnish a comprehensive solution for the array of performance management issues faced by today’s managers despite its implicit call for such a holistic approach in its purpose of â€Å"searching for ways to build lean, adaptive and ethical enterprises that can sustain superior competitive performance†. Perhaps incorporating the BBRT’s recommendations into Kaplan and Norton’s broader balanced performance management scorecard approach, (1996: 44)—financial, customer, internal business process, and learning and growth perspectives—would yield a significantly stronger and more comprehensive approach for modern organisations. References Beyond Budgeting Round Table (2007) â€Å"About Beyond Budgeting – Concepts†, available from http://www.beyondbudgeting.plus.com/BBRTweb4/bbconcept.htm [Accessed: 7 March 2007]. Beyond Budgeting Round Table (2007) â€Å"About Beyond Budgeting – The Budgeting Problem†, available from http://www.beyondbudgeting.plus.com/BBRTweb4/bbprob.htm [Accessed: 7 March 2007]. Beyond Budgeting Round Table (2007) â€Å"About Beyond Budgeting – The Principles†, available from http://www.beyondbudgeting.plus.com/BBRTweb4/bbprinc.htm [Accessed: 7 March 2007]. Beyond Budgeting Round Table (2007) â€Å"BBRT Beyond Budgeting Round Table†, available from http://www.beyondbudgeting.plus.com/BBRTweb4/index.htm [Accessed: 7 March 2007]. Coombs, Hugh (2005) â€Å"Budgets Should Be Geared for Rapid Response†, Western Mail, June 18, 2005. Fraser, Robin (2000) â€Å"Beyond Budgeting: Organizational Devolution and Performance Management†, Strategic Finance, October 1, 2000. Fraser, Robin (2001) â€Å"Figures of Hate: Beyond Budgeting†, Financial Management (UK), February 1, 2001. Kaplan, Robert S., and Norton, David P. (1996) The Balanced Scorecard, Boston: Harvard Business School Press. Parmenter, David (2003) â€Å"Abandon Budgets and Set Your Enterprise Free†, New Zealand Management, October 1, 2003.

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