Weaknesses of Traditional Budgeting

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Beyond Budgeting > Best Practices > Weaknesses of Traditional Budgeting

Weaknesses of Traditional Budgeting
Anneke Zwart, Student (University), Netherlands, Moderator
Fraser and Hope mention the main weaknesses of annual (traditional) budgeting that gave rise to the development of thinking beyond budgeting:
1. Time Consuming - Budgeting takes a lot of time. Average time needed for budgeting lies between two and four months according to the authors.
2. Costly - Despite developments of high quality and fast computer networks, the process of budgeting still remains to be expensive.
3. Useless - After visiting several companies, it appeared that many companies perceived the results of budgeting differently. Budget gave some companies more control, while in other companies budgeting was perceived as being unimportant and not meeting any needs.
4. Bureaucratic - The continuous pressure on prices of goods and services asks for decreases in structural costs and in bureaucracy.
5. Frequency - Initially changes in the competitive environment resulted in budgeting more often in a year, but its only result is a rising workload that is especially high in reorganizations and M&As.
6. Changing Environment - Budgeting has been successful in more stable environments, but it is no longer efficient in the changing competitive environment.
Are we missing any further weaknesses of classical budgeting, or is this list complete?
Hope, J. and Fraser, R. (2003) “Beyond Budgeting: How Managers can Break Free from the Annual Performance Trap”. Harvard Business School Publishing Corporation.
 

 
On Weaknesses of Traditional Budgeting 6b: Changing Economic Enviroment
Nita, CEO, United States, Member
Hi, Anneke,
I like your observation that budgeting has been successful in stable environments, but is not efficient in the changing competitive environment. I would suggest that it is also not effective in the changing economic environment.
Cheers! Nita.
 

 
On Weaknesses of Traditional Budgeting 5: The Trisemester Way
Arif ur Rehman, Professor, Pakistan, Member
In academics the fundamental shift from annual examinations to semester and finally trimester system was in response to rapidly changing corporate and business needs – both at regional and global levels.
At the same time they proved to be student-friendly too.
Anneke’s observations are both timely and meaningful. However, with the same rationale as the trimester exams, if annual budgeting would be done ‘trisemesterily‘– supported by highly developed IT budgeting software– then the impact of change at breath-taking speeds, would be absorbed both seamlessly and proactively.
 

 
Weaknesses of Traditional Budgeting: 7. Budgeting is Often not Integrated with ERP
Jagdish B Acharya, Consultant, India, Premium Member
From past business results, vision of business leaders and future plans, management may prescribe limits on expenditure in the form of budgets.
As economies are very dynamic, thinking of itemised budgeting takes a lot of time (especially since budgeting is often not integrated with ERP) and may not be relevant now.
ERP integration of budgets might show the manager online how much of budget provision is being used by the decision. This will help in yearlong continuous decision-making in the light of budgets.
 

 
On Weaknesses of Traditional Budgeting 3: Now Useless
KALOGO PAUL, Student (University), Uganda, Member
This weakness of traditional budgeting in many organisation is that it was originally made as a reference tool for planning purposes.
Yet nowadays few organisations stick to their budgets, hence compromising performance.
Indeed in this chancing world traditional budgeting is not appropriate anymore.
 

 
On Weaknesses of Traditional Budgeting 3: Use Budgeting Appropriately
Alpin McGregor, freeelance, United Kingdom, Member
Surely problems arise with budgeting when it is not used appropriately.
It will be used inappropriately by those who don't understand how budgeting should be used and using it for purposes it was not designed for.
The weakness is then in the management who don't understand what they're doing...
 

 
On Weaknesses of Traditional Budgeting 3: Don't Use Budgeting for History Only
George Kerstholt, Strategy Consultant, Netherlands, Member
If budgeting is used as a means of reference for achieved results (history) (as nowadays is often the case), yes it will work adversely.
However when 'what-if' scenarios for future dynamics are included, it will prove to be a very effective and meaningful tool for (strategic) management.
 

 
Budgets... They Have a Place But When Misused!
Donald Liveley, Teacher, United States, Member
Budgets are about compliance (tactical) rather than the long term strategic and eventual survival and robustness of the enterprise.
I believe that ABC (Activity Based Costing / accounting) is better to help to understand the relationships between the streams of cost and revenue. That has to align with all the stakeholder and marketing assessment.
So budgets are all about the normative and compliance. Budgets can turn any robust institution into a stodgy dodgy bureaucracy. That is why I believe that ratios and percentages are sometimes better structural measurement tools.
Traditional budgeting can work if you have a heavy dose of statistical analysis (not debits and credits) to correlate, infer and project what has happened and is unfolding.
Again, traditional budgets are normative and will maintain the status quo. Need to avoid that. Structure is critical, but control can be counter productive. So statistics and a respect for "economics" beyond the debit and credit is needed. Also, budgets are about turfs and egos. Bureaucracies are the darkest (political) form of entities.
 

 
Weaknesses of Annual Budgeting: 8. Perspective of Cost Control
Hakvoort, Business Consultant, Netherlands, Member
What's the definition of traditional budgeting? Traditional budgeting is mostly perceived out of the perspective of cost control. This is a weakness, a better perspective would be added value (not only quantified in money).
At the end it all relates to which detail you're working and the trade-off between transactional costs of the budget process itself and the value which comes out of this process.
Two dimensions are key, being horizon (time scale) and scope (area) regardless of which type of organization.
 

 
On Weaknesses of Traditional Budgeting 3: Not Useless...
palermo, ICT Consultant, Chile, Member
Hello Anneke, I agree with your statements except in that the traditional budgeting is useless. I believe it is useful and have to agree with @KALOGO PAUL that it is a reference tool for planning purposes.
However, another major problem exists, regardless of the annual budget, in the case of outsourcing for example, there must be calculations of the value for the money spent, even if it is within the annual budget it may just be a waste of that money. L.
 

 
Weaknesses of Traditional Budgeting: 9. Included in Project Management Tools
CHIEDU UDE, CEO, Nigeria, Member
Ensuring discipline and control are essential attributes of traditional budgeting, and have proved quite useful. Nations and state bureaucracies still need traditional budgeting.
But organisations that adopt modern project management models have budgeting as integral parts of these models, hence traditional budgeting may no longer be attractive.
 

 
Another Weakness of Budgeting: 10. Vulnerable for Cost Cutting
ADAM SAID, Student (Other), Member
The mentioned weaknesses of (traditional) budgeting are very pertinent.
I suggest also this one: some companies are following their normal budgeting process, but (because of the economic situation) are applying cost reductions to the budget, trying to retain profits. The final budget is then reduced and does no longer reflect the real needs.
For example in a manufacturing plant, the equipment has to be maintained and finally, at the end of the year, the actual ends up above the budget.
 

 
All Mentioned Weaknesses do not mean Budgeting is Useless
Sergey Baltin, Manager, Russian Federation, Member
When you at the very beginning of installing budgeting in your company - you face all these 10 weakness mentioned before.
The main aim of management should be to solve these weaknesses by adapting budgeting, integrating it with ERP, involving scenario-planning etc.
Don't forget budgeting is a basic instrument of planning and essential part of management evolution in company. I warn you all from total censure (by using the word "useless") of budgeting.
New minds, new companies, recent students which nowaday managers - they all may understand it as a guide to action (that is non-action).
Note by Editor: To be as informative as possible, any discussion at 12manage is always dealing with 1 topic only. In this case the topic is: "weaknesses of traditional budgeting". Of course this does not mean that budgeting has no benefits or advantages. But that would be another topic.
 

 
Further Weaknesses of Traditional Budgeting
K.Narayana Moorthy, HR Consultant, India, Member
- It is not oriented to long-term vision.
- If it follows bottom-up method it's tedious and if it follows (many a time) top-down method it's painful to deliver.
- It does not get into budget profitability.
- Expense allocations are not following more meaningful calculations.
- It is neither activity based calculations nor activity based costing.
- It does not aim at future realities.
In to-day's competitive business, the above would be very costly to business.
 

 
Waste of Energy, Causes Sandbagging
JC de Jong, Director, Netherlands, Premium Member
Hello Anneke, I agree with your points and the two I would like to add are (one already being mentioned)
1. Lack of long-term visioning (budgets almost always in the western world are annual budgets and organisations are driven by quarterly results)
2. The waste of energy between the different layers in organisations including the game of sandbagging, a game where there are no winners. Best regards.
 

 
On 3. Useless: Managers don't see the Value of Budgeting
jiun, Student (University), Malaysia, Member
The weak points and strengths of budgeting should be determined by the management. What I have observed is that managers indeed do not really fully utilise the "power" of budgeting and only treat it as a figure. This also due to a stiff mindset.
 

 
Budgeting-Rocket Science?
Istvan Szeman, Consultant, Hungary, Member
@George Kerstholt: My observation is budgeting is still a great approach to maintain control and quantify strategies, obviously it has to go beyond planning.
Budgeting needs to deal with actuals and accruals (both prompt and forecasted), scenarios and auditable changes, if necessary.
Of course there are a number of difficulties, at least...
- In complex organization the process of planning and re-planning involves many people, hence the process is lengthy.
- The cost structure is shifting from direct costs towards indirect costs, and that calls for more cost allocation in the planning and accounting/reporting process.
- Providing the fast and efficient IT in support of the full budgeting cycle is a challenge in itself for a complex organization.
 

 
Missing Process and Software Support
Istvan Szeman, Consultant, Hungary, Member
One essential (and missing) building block is a well defined process and software support for forecasting budget positions, based on recent trends, cost/revenue patterns, etc..
Similarly, very often a formal procedure for pre-approval of unreserved budget exists, but not supported by IT systems.
Both of these would be helpful for managers to proactively look for best use of their budgets (as opposed to merely staying within budget).
 

 
Weaknesses of Traditional Budgets
NANG Theophile, Student (University), Cameroon, Member
Hi all, I appreciate what is previously said by @Jagdish and would like to agree with @jiun that budgeting, wether annual or shorter, also suffers from some management misunderstandings/malpractices.
Some managers may believe that reducing costs to increase margins is the best tactic. By doing so, they may not consider (enough) the required resources to produce, the long term aims of values creation, and customer satisfaction.
For effective and realistic budgeting, it's key to have it closely linked to the organization changing needs and resources. ERP tools and likely can be helpful to have regular budget updates according to organization changes.
 

 
Weakness of Traditional Budgeting
Dobson, Project Manager, Canada, Member
I agree with @ADAM SAID that typically budgeting takes on a 'changes around the edges' approach, with incremental adjustments usually spread broadly across all areas, this done in an attempt to avoid the tough decisions and instead spread the pain more or less evenly around.
The consequence of this is really to spread mediocrity throughout the organization. Better to set clear strategic objectives that are aligned with the vision and prioritize budget allocations based on those strategic priorities. Then use performance indicators and targets to evaluate effectiveness of achieving desired results.
 

 
Weaknesses of Annual Budgeting
RUBEN ACOSTA, Manager, Mexico, Member
Dear Anneke, you are just right in your observations. Dou you have any better way to improve this process? Is it possible to reduce to 50% of current time at least? What do you think?. I will propose for instance to continue with the latest budget and just keep going as monthly forecast instead of start doing again the full budget. This action will take only 1 day instead 4 months and the result will be very similar against doing the full process. The only time to do a full budget is whe your business will have a significant change or your customer base will change. Changes that imply that you must change the way you do business now.
 

 
Lack of Process and Software..
Donald Liveley, Teacher, United States, Member
The reason that processes and technological support is not as optimal as it should be, is the concepts/principled are not well conceptualized. Process must always follow principle. With out a principle based understanding - the processes will be arbitrary and poorly constructed and instituted. Again, I will say as I have said before - you must understand the social (stakeholders) factors and correlations. That assumes you understand the moral intelligence of a group. Principle base actions must be grounded in correlation. I am suggesting a deeper direction than just the numbers... But also to better understand and grasp the many correlations. And until we develop correlation intuitively in our day to day efforts we will flounder with processes and technological support. My sense is over the last 30 years we have mostly automated, but have not "grounded" in correlation what the heck we are trying to do!
 

 
Weaknesses of Traditional Budget, 3 Useless
Adam Mohammed Baba, Director, Ghana, Member
Political interference as a result of political expediency also distorts implementation of traditional budget.
This is more pronounced in the economies of developing countries, especially by the local government authorities. Though the process of preparing budgets for local government authorities in some developing countries in Africa is mandatory, time consuming and costly, they are not appropriately implemented for reasons mentioned earlier.
However if budgets are appropriately prepared and implemented, they do provide effective tools for control, monitoring and value for money.
 

 
Weaknesses of Traditional Budgeting
K.Narayana Moorthy, HR Consultant, India, Member
I agree with Adam Mohamed Baba - budgeting must be of value of money. Basically, if the budgeting is based on activity calculations and activity costing - even the political interference can be stopped.
 

 
This is a Good Observation
Nita, CEO, United States, Member
@K. Narayana Moorthy: You are right, although I never thought of it that way before. It is very difficult indeed to argue with cold, hard numbers in black and white.
 

 
Careful with the Effectiveness of Numbers
ADAM SAID, Student (Other), Member
I think indeed numbers are effective tools for decision making, but the issue is the reliability of these numbers.
When the process for producing the numbers is not properly followed, good decision can not be taken.
 

 
Weaknesses of Traditional Budgeting
Michael T Iorngurum, Manager, Nigeria, Member
Your reasons are cogent (Editor: ~convincing). Particularly observations 3 and 4 (Useless, Bureaucratic). In a process manufacturing plant, they are especially true.
While expenditures may require lengthy approval processes, the plant conditions under which they were made can continuously change, making final approvals useless. This can happen even in a stable economic environment.
Coping in changing environments requires frequent monitoring and changes in planning.
 

 
Weaknesses of Traditional Budgeting
George Kerstholt, Strategy Consultant, Netherlands, Member
@Istvan Szeman: unless I misunderstand you. Imho budgets are usually used as a reference of short-term (1-3 years) results to be achieved against minimum (budgeted) costs; extra costs despite the extra results are often unacceptable due to being "not budgeted". Hence the administrative process (which is not equal to compliance!) slows the market capability. Marketing-windows can not be utilized. So the company meets its budget (cost reference), but loses market share.
Hence proper (data) dashboards for all departments should be utilized to the fullest which unfortunately often is not the case..
 

 
Weaknesses of Traditional Budget
K.Narayana Moorthy, HR Consultant, India, Member
While it is agreed that a budget is important, it can not be simply followed in completion of work. Especially in a changing environment with high levels of competition involved, changes and modifications become paramountto deal with these situations.
 

 
Weaknesses of Traditional Budgeting
Istvan Szeman, Consultant, Hungary, Member
@George Kerstholt: I agree with you very much with regards to usual practices and its limiting factors. The consequence is not only missing potential growth opportunity, but also some sacrifice in cost-efficiency: all budget holders spend their budgets by the end of the fiscal period and find their justifications to do so.
The alternative to this is the comparison of budget-scenarios including projection for exactly 2-3 years.
 

     
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