Behavioural Aspects of Budgeting PDF

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Behavioural Aspects ofBudgetingBudgetary ControlBudgetary control implies the existence of a predefined budgetary standard and subsequent feedback mechanism to support the evaluation and possible correction of actual performance.A budget is a way of delegating authority. They don’t reflect reality, ...

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Behavioural Aspects of Budgeting Budgetary Control Budgetary control implies the existence of a predefined budgetary standard and subsequent feedback mechanism to support the evaluation and possible correction of actual performance. A budget is a way of delegating authority. They don’t reflect reality, they should be viewed as a forecast. Any budgetary control system set up should ensure that:  Allowing managers to set their own targets improves motivation, commitment and performance  The environment the business operates in, is fully understood;  The business develops an appropriate culture;  The role of the budget in terms of its fit with the strategic plan is clearly understood;  A culture of value-adding is developed Necessary Conditions for Budgetary Control:  A serious attitude from all levels of management  Clearly defined areas of managerial responsibility  Reasonable budget targets (focus on achievability)  Established data collection, analysis and distribution  Specific rather than general-purpose reporting  Fairly short reporting periods (e.g. monthly)  Timely variance reports made available to managers  Action taken to regain control

Standard Quantities and Costs Most budgets are built on standard assumptions. Planned quantities and costs (or revenues) for units of input or output:  Form the ‘building blocks’ of the budget  Represent targets and therefore benchmarks by which actual performance is measured  Are the basis of calculation for most variances  Should be reviewed regularly and revised if necessary  Also have uses beyond the context of budgetary control

Investigating Variances     

Can be both time-consuming and expensive Only useful if management gains the means to regain control so future targets can be met Significant adverse variances represent a potentially very costly fault and should be investigated Significant favourable variances represent things not going to plan and may mean targets are too low Insignificant variances should be kept under review in case they are not the result of chance factors

Limitations of Budgetary Control Budgetary control assumes a situation in which a predictive model is explicit and available to managers. Managers make programmed decisions where the decision situation is sufficiently well understood for a reliable prediction of the decision outcome to be made. However, this is not always possible where decisions largely rely on the judgment of managers because there is no formal mechanism available for predicting likely outcomes. In such situations, predictive models are only implicit in the minds of individuals who are more responsible for results rather than how they are achieved.

Limitations of Control Through Variances and Standards Budgetary control, while useful and valuable also has limitations including:  Not all expenses can be directly linked to productive activity  Standards can rapidly become obsolete due to technological and price change factors  Factors outside of management control can impact  Delineating management responsibility may prove difficult in practice

Behavioural Aspects of Budgetary Control Research indicates that:

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Existence of budgets tends to improve performance Demanding but achievable targets seem to motivate more than easy targets Unrealistic targets adversely affect performance

Allowing managers to set their own targets may result in them establishing easily achievable targets. Alternatively, they may set targets too high in a misguided attempt to impress. The solution lies with the budget review process that should take the form of a constructive dialogue.

Top-down Limits involvement and ‘buy-in’ of staff who will subsequently be responsible for achieving the budget objectives. Bottom-up Sometimes referred to as “participative budgeting” Improves the quality of the information used for budgeting as it is derived from front line staff who have a more direct and immediate knowledge of the local environment and issues. Improves motivation and ownership of the budget as staff are more likely to work to achieve a budget that they have been involved in setting Requires coordination and resolution of conflicts

Motivation A budget represents a target and aiming toward a target can be a powerful motivator. However, when the target will cause employees to do better is thought to depend on how difficult the target is perceived to be. If targets are set very low, performance can be pulled down from where it might naturally have been. If targets are habitually very high, then employees might give up and, again, performance can be reduced – if you know no matter how hard you try you will fail to meet the target, it’s easy to decide you might as well not try at all. So, the aim is to set budgets which are perceived as being possible but which encourage employees to try harder than they otherwise might have done. Although a budget which is best for motivating might not represent the results which are expected, managers can, and perhaps should, build in a margin for noble failure.

When the budget is very easy, actual performance is low. It has been pulled down by the low demands made on the employees. When the budget is very difficult, actual performance is low. Why try when you are doomed to fail. When a budget is set at the level of the expectations (the best estimate of what performance will actually be), employees are likely to perform as expected. If a more difficult aspirational budget is set, employees will try harder, and if the budget is judged just right then their actual performance will be at its maximum, though often falling short of the budget.

Evaluation Evaluation of actual performance against budgets can be contentious:  The budget might simply have been wrong, i.e. unachievable from the start;  The budget might have become unachievable because of changes to external factors;  The performance of one part of the organisation might interfere with another;  Elements of the budget might be incompatible so that meeting one target could result in missing another;  Decisions that support the achievement of longer term objectives could have an adverse effect in the short term. Example

As a factory manager in a furniture manufacturing company you discover that a component in one of your key machines is broken and needs to be replaced so that an important order can be completed on time. However, there is no provision for the cost of that replacement in the current month’s budget. Do you replace the component this month, and go over budget, or wait until next month and stay within budget? Budget Constrained Style • You could be criticised because the repair budget was exceeded. • This could lead to a poor relationship with your manager and may tempt you to manipulate and mis-report information. Profit Conscious Style • You are judged on your ability to increase the long-term effectiveness of the organisation. • Budgets are not ignored but regarded more as guidelines than strict targets; they are interpreted flexibly. • You are therefore more likely to be praised for getting the machine repaired as that enables the organisation to meet customers’ needs. Non-Accounting Style • It is difficult to imagine a successful organisation which is not subject to financial and therefore budgetary constraints. • But there may be elements of the organisation where money is relatively unimportant. • An airlines’ health and safety requirements will need to be maintained because the consequences of not doing so would be disastrous.

What gets measured gets managed? Whatever gets formally set as an organisational objective will be measured. (Note there may be informal objectives). What gets measured will tend to attract the focus of management – particularly if it is used for individual performance evaluation. The risk is then that other important aspects of performance are not measured and therefore do not receive adequate management attention. The solution is to develop a comprehensive set of budget objectives that encompasses all of the key elements of organisational performance.  Financial measures  Customer/client measures  Internal business measures  Innovation and learning measures

Criticisms of Budgets              

Time consuming and costly to put together Budgets are rarely strategically focused Often associated with an overly inward focus Budgets may lead to department centeredness Different budgets needed for planning, control and motivation Budgets can stifle the entrepreneurial spirit needed to create value Budgets are out of touch with the needs of modern business Budgets dealing with Increases in technology may lead to more centralisation at the cost of greater involvement Budgets can be seen as a bureaucratic exercise in cost-cutting Behavioural aspects are often misunderstood, leading to perverse behaviour When managers are in a position to influence budget figures, the danger of bias exists Budgets may make people feel under-valued Budgets can stifle projects because resources are already allocated A system of accountability may create a counter-productive atmosphere of blame and mistrust

Beyond Budgeting … realized that management processes (the way we set goals, strategy, plans and budgets, allocate resources, coordinate actions, and measure, reward and control performance) with budgeting at their core were not neutral in terms of management thinking and behaviour. In fact, these processes were designed to enable leaders to command and control the actions of front-line people. Head office did not want managers to think or act on their own. In fact, they didn’t want any surprises. So if leaders now wanted managers to be more responsive, innovative and ethical, what did they need to change? The answer was not about fixing a few problems. It required a new way of thinking about management. It meant designing a new coherent management model Is this how we want to run organisation? As cogs in a machine?

Measurement Replaces Management The core assumption is that everything is controllable if an organization can be broken down into its constituent parts and the right steering mechanisms and metrics used to ensure that each part achieves its optimum performance (each part is likely to have its own target and measures independent of others). If there is a problem with any part, a range of ‘tools’ can be used to ‘fix’ or ‘reengineer’ the problem. Given a complex environment the only way that complex organisations can be successfully controlled is through exploiting the capacity of a system for self-organisation and self regulation.

In other words, we need to adopt an organic model. Systems are understood as whole systems, and attention is given to relationships within those systems. But there is deep cynicism about these approaches based on machine-like assumptions. It is increasingly tough (and expensive) to keep strategies, structures and systems in constant alignment in an unpredictable and changing world. Change is invariably reactive and disruptive and endless restructuring, reorganizing and reengineering programs come and go with, in most cases, temporary relief but little longer-term effect. Employees are small cogs in this giant organizational wheel of fortune. The result is that leaders consistently fail to connect with their people and thus miss the opportunity of harnessing a potentially huge store of ‘free’ knowledge and creativity. To understand things systemically literally means to put them in context, to establish the nature of their relationships. When we view systems from this perspective we enter an entirely new landscape of connections, of phenomena that cannot be reduced to simple cause and effect, or explained by studying parts as isolated contributors. We move to a land where it becomes critical to sense the constant workings of dynamic processes, and then to notice how these processes materialize as visible behaviours and forms....