Budgetary control Essay.
Nowadays management’s philosophy revolves around the idea of planning. According to McKinsey (1922), chief executives have come to the realization that today’s task can only be properly fulfilled thanks to the meticulous planning of yesterday. The budgetary control framework has been openly accepted and widespread as a tool for management and overall organisation control. Nonetheless, recent evolutions in the managerial sciences have come to jeopardise the reliability of budgeting as an effective method for the control of performance and organisation.
The concern of whether budgeting is in fact an apt tool has created mixed views and debate amongst scholars. This essay will aim to evaluate whether budgetary control is concerned primarily with the control of performance, or if it has of late taken on greater importance especially as a more integrative control mechanism for the organisation. In order to do so it will firstly define the meaning of two fundamental concepts such as budget and budgetary control.
Secondly it will evaluate the use of budgetary control as a tool for today’s organization.
Thirdly it will follow debates and criticisms on its the effectiveness and use and Lastly it will conclude by assessing to what extent budgetary control has become a more integrative control mechanism for organisations. The work of key specialists in management such as Bhimani, Otley, Van der Stede and McWatters, will be drawn on in order to cover the key issues of the discussion.
Before commencing on a discussion of budgetary control, it is immanent to clarify and define the two key terms that will be used in this essay: ‘budget’ and ‘budgetary control’. On the one hand, as defined by Bhimani et al. (2008) “a budget is a quantitative expression of a proposed plan of action by management for future time period and it is an aid to coordination and implementation of the plan”. On the same line McWatters et al.
(2008) highlights the importance of budgets as a planning control system for a company, which ‘translate’ organisational objectives into financial terms. Drury (2009) exemplifies the many different purposes that budgets serve, such as: coordinating activities, conveying various arrangements to different responsibility centres, arranging and controlling operations, motivating employees to attain organisational objectives and assessing the execution of managers.
According to Johnson (1996), it was in the 1960s that associations started to highly regard the utilization of budgets as tools for performance measurement and the control of managerial objectives. On the other hand, budgetary control is described by Periasamy (2010) as “a system of controlling costs which includes the preparation of budgets, coordinating the department and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability”.
A similar, yet more formal, definition of budgetary control is given by the Chartered Institute of Management Accountants of England and Wales (CIMA): “the establishment of budgets relating to the responsibilities of executives to the requirement of a policy and the continuous comparison of actual with the budgeted results, either to secure by individual actions the objectives of policy or to provide a basis for its revision”. There are two main purposes of budgets which scholars have identified: planning and controlling.
The first purpose, which McWatters et al. (2008) discusses, is that budgets have a fundamental role in undertaking planning decisions. In fact, the integration of budgets into a strategic planning of long term and short-term objectives is crucial to the harmony of the project itself. This claim can be explained by Bhimani et al. (2008) who proposes that, budgets provide a more realistic view on the possible outcomes of investments, which consequently leads managers to adjust their strategic goals accordingly.
To put it another way, when a company wants to match its potentials suitably with the prospects of the marketplace, it undertakes a strategic analysis to then set several long-run and short-run goals. On this basis a budget is formulated. However, as stated before, once the budget that has been formulated projects a more realistic view on the strategic objectives, these strategic objectives are then readjusted once again. The second purpose that Emmanuel et al.
(1990) discusses is to do with budgets as a form of control and a tool for monitoring a company’s performance. McWatters et al. (2008) describe this function by outlining the idea that budgets are frequently used to assign responsibilities by allocating resources to different managers. A budget may be given with more or less flexibility, for example by assigning a large sum of money for ‘advertising’ to be used at the managers discretion, or by highlighting the different ways that this money should be used.
The optional flexibility of budgets allows for a company to give the adequate level of responsibility to its employees and thus the organisation is able to maintain a level of control. McWatters et al. (2008) further elaborates on the function of budgeting for control by suggesting that “the numbers in a budget are also used as goals to motivate organisational members”. This motivational aspect of budgeting can be explained by Bhimani et al (2008) who states that “the manner in which a budget is administered can adversely impact on the managers’ behaviour”.
A manager must believe that the budget is achievable in order to actively attempt to pursue it, Bhimani et al (2008) adds that through the constraints and goals set by budgeting targets, managers are often motivated to “effect changes in a forceful way”. The way that a budget is formulated, and the demands and pressures that it targets are key in encouraging the right degree of motivation, “an enterprise can set a difficult to attain budget in an attempt to motivate good performance.
This is because, in practice, budgets that are set up to a certain degree of tightness often become stronger motivators” (Bhimani et al. , 2008). A final point to consider with the role of budgetary control is the function that it plays in enhancing communication within a company. Internal coordination between the steps of production , as well as communication among departments are key aspects for a company’s performance. Dury (2009) states that “the budget serves as a vehicle through which the actions of the different parts of an organisation can be brought together and reconciled into one common plan”.
Hence, hierarchical and inter-departmental communication within the organisation is extremely facilitated thanks to the use of budgets. For instance, considering a multinational corporation that, due to its size, has difficulties in communicating between the production department and the sales department, budgets could in this circumstance be the most operational manner of communicating, as they set common goals between different departments. As it is clear form the paragraphs above, the controlling side of budgets play a stronger role than the planning aspect.
An example that instead criticise this view can be found in the strategic planning of investments. Maximising performance of a company can be synonymous for maximising the shareholders value. Akintoye (2008) argues that equality in investment decisions are fairly dependent on the solidity of the budgetary control system, which in turn is key to maximise the company’s shareholders value. Therefore, it is arguable that a weak budgetary control system may be the cause of unprofitable investments and consequently may trigger the loss of shareholders value (Akintoye, 2008).
There are many examples that reflect this issue, such as one reported by the European Journal of Economics Finance and Administrative Science where the Coca-Cola Company, with the purpose of differentiating production, failed miserably in their investment on food and wine in that the investment rate of return resulted to be beneath their cost of capital. The tremendous loss of money caused by this investment and other failures of this type grab the attention of scholars, raising questions on the salience of the budgetary control system, as well as whether budgets are mainly used to control or plan organisations.
Other criticisms towards budgetary control as a main form of performance control, argue instead that the use of budgetary control in performance management has of late taken on greater importance especially as a more integrative control mechanism for the organisation. This stands on the basis of different points of view of the role that motivation and communication play within a company. Bhimani et al. (2008) argues that current speculation concerning budgetary control systems prescribes two inverse perspectives.
From one perspective, there is the view that upholds incremental change to budgetary process in terms of interfacing such forms more closely to operational prerequisites, arranging frameworks, expanding the recurrence of plan amendment and the arrangement of rolling budgets. A second perspective supports the abandoning of the budgetary control system as a method of organisational control, and supplanting it with elective systems to empower firms on their adaptability and adjustability. The second perspective arose because of the consequences caused by the conflictual role of budgets between planning and controlling.
To summarize; in planning and settling choices, budgets convey specialised information between different departments and hierarchy of the organisation, whereas for control, budgets serve as benchmarks for performance measurement (Otley, 1978). According to McWatters et al. (2008) if too many boundaries are placed into performance targets, then specialised executives will settle down and stop disclosing accurate predictions of prospected occurrences, and instead rely more on budgeted figures, which ease the achievement of the targets. A clear example of this conflict is given by the marketing sector.
Salespeople according to McWatters et al. (2008) are usually very specialised and can very well forecast future sales. Their predictions are very important to settle the amount of goods to be produced. Inasmuch budgetary control of sales takes place at the end of the year, and it is used as a tool to evaluate performance. Salespeople are reasonably incentivised to under-forecast future sales in order to assure a positive evaluation of their performance. Nevertheless this behaviour induces the company to have higher production costs, creating counterproductive results.
However, this behavioural theory is contrasted by Van der Stede (2000) in his study on the relationship between two consequences of budgetary control: slack creation and managerial short-term orientation. In his experiment he attempts to find the relationship between rigid budgetary control and slack creation, where he defines slack as the action by business unit managers that leads them to “… exploit their position of superior knowledge about business possibilities vis-a-vis corporate management to get performance targets that are deliberately lower than their best guess forecast about the future” (lukka, 1988).
Van der Stede’s (2008) statistical correlation showed in fact that rigid budget control reduced slack. To strengthen his view, Bhimani et al. (2008) states that “budgeted performance measures can overcome two keys limitations of using past performance as basis for judging actual result”, meaning that, not only budgetary control is a good “judge” of performance, but it also develops better aspects in comparison to other evaluation techniques. In conclusion, this essay has highlighted the role of budgetary control and it’s functions in terms of planning the organisational control of a company, as well as its role in performance management.
Motivation and communication are both key aspects in the management of performance, and both of these functions are met through the system of budgetary control, either by setting achievable incentives, or by providing the necessary requirements to improve communications within a company. Having underlined the role of budgetary control as an enhancer of performance management, it is clear to see how it has become a key mechanism for the integrative control of an organisation. Nonetheless, this essay has outlined some of the key disputes of the reliability and effectiveness of budgetary control as an adequate method of performance management.
An example of this is highlighted by the fact that when managers are given strict budgeting figures, they sometimes deem the goals to be too easily achieved, and hence give a lesser input of motivation. Despite the many critics of budgetary control as a tool for the organisation of a company, scholars such as Van der Stede (2000) and Bhimani et al. (2008) have confidently stated that when a budget is set correctly, it can significantly improve an organisations performance, including the integrative function within a company; and is in fact a more effective tool than other existing methods of control.