Week 7 - Budgetting

Question 1

Why do we need budgets?

Answer 1

Coordination - decisions taken for best interest of organisation rather than individual business segments

Planning - Forecasting

Monitoring - Comparing actions and progress to plan objectives to avoid deviation

Question 2

Criticisms of Budgeting

Answer 2

Incremental:
Perverse inventive not to exceed target, Perverse incentive for those exceeding target to reduce effort

Slack:
Targets easy to achieve, inefficient, not motivational, can be helpful for coping with uncertainty, useful in protecting innovation?

Question 3

Are budgets still useful?

Answer 3

Libby & Lindsay (2010):

Medium & Large-sized orgs in North America:
- 80% of respondents said that budgets used for control purposes, including managerial motivation and performance assessment
- Majority of respondents believe budgets to be value-add and indispensible

Question 4

3 Main budget approaches

Answer 4

Incremental:
Existing operations taken as starting point

Zero-based:
Projected expenditure starts from ‘base zero’ rather than last year’s budget, forcing managers to justify all expenditure

Rolling:
Budget kept continually up-to-date by adding another accounting
period (e.g., month or quarter) when the earliest accounting period
has expired.

Question 5

Incremental Budgeting
Pros and Cons

Answer 5

Pros:
- Quickest and easiest method
- Suitable if company is stable

Cons:
- Builds in previous problems and inefficiencies
- Incentives to overspend

Question 6

Zero-based budgeting

Answer 6

Pros:
- Value for money
- Efficient resource allocation

Cons:
- Long & complex
- Short termism

Question 7

Rolling budgeting
Pros & Cons

Answer 7

Pros:
- Dynamic
- More up to date

Cons:
- Long and costly
- Demotivation risk

Question 8

Top-down budgeting
Pros & Cons

Answer 8

Pros:
- Ensures consistncy with strategic plans
- Decreases input from inexperienced managers
- Budget produced quicker

Cons:
- Potential for unachievable budgets
- Low acceptance of the budget by those actually applying it e.g. managers
- Loss of training and progression opportunities for staff

Works in:
Small businesses (where senior managers are well informed)
Where lower managers lack budgeting skills

Question 9

Scenarios when Bottom-up budgeting is well-suited

Answer 9

Pros:
- Based on info from those who may be better informed
- Knowledge from all operational levels pooled together
- Specific resource requirements included, maybe more in-depth
- Increased commitment to budget

Cons:
- Takes longer
- Budget slack (padding) may be introduced to give managers more leeway
- Requires managers to be skilled in budget setting

Works in:
Well established companies

When managers have strong budgeting skills

When different units act autonomously

Question 10

Problems with budgets

Answer 10

Lack of coordination between budget setters and those implementing them
Build slack into budget
May just try to achieve target rather than exceed it
Managers often spend whole budget allowance even if unnecessary
Managers may be held responsible for factors outside of their control

Question 11

Svenska Handelsbanken: Beyond Budgetting

Question 12

Bourmistrov & Kaarbøe (2013)

Answer 12

Traditional budgetting creates “comfort zone” for managers to operate in risk-free environments

Authors want “stress zones” that use beyond budgetting approaches of Dynamic forecasting (rolling budgets), decentralised decisionmaking

Focus on long term impacts of goals, not just annual