Advantages and Disadvantages of Corporate Budgets

Before beginning to comment on the usefulness of corporate budget, it is important to know what is the meaning and purpose of budget for a corporation. A budget is basically a financial planning tool which the organization uses to plan its expenses from the revenue. A budget is a comprehensive summary of the planned expenses and revenues of an organization which is used throughout the year.

The main purpose of making a corporate budget is to forecast the revenues and expenditures so that particular strategies and events can be undertaken to achieve similar financial performance (Kemp & Dunbar 2003). The budgeting also enables the organization to compare the actual financial performance of the business against the forecast.

Corporate budget is the annual budget compiled by the organization and is different from the start-up budget. It is a budget which is compiled by the finance department of an organization after every department contributes its expected revenues and expenses.

This way a final corporate budget is drafted through the considerable effort of various people and technology in the organization and this serves as a financial plan for the new financial year (Shim & Siegel, 2008). The actual financial performance of the company in numbers is compared to the forecasted numbers and if this matches reasonably then this means that budgeting is of good use for the business.

But if the actual numbers diverge considerably from the expected numbers then this means that budgeting is not useful for the company and business is not going in the intended direction. Budgeting is basically a tool organizations use for planning and controlling their organization’s financial performance.

Previously, this task was mostly centralized but with changing times it has become a company-wide effort with all the managers and employees contributing to the final budget.

The traditional method was the bottom-up approach in which the every department provides its expected revenues and request expenses which are then accommodated into the corporate budget but this approach is now being integrated with the top-down approach to budgeting where the top management defines the strategic objectives and then the budget is prepared by departments.

What usually happens is that budgeting and forecasting starts with the previous year’s numbers which are incorporated into the new budget.

But business are adopting strategic business planning where budget planning is based on the annual company’s objectives and then the budget is planned accordingly to achieve the desired goals for example, the objective is to increase the sales by 10% then more revenues and expenses are forecasted to achieve the increased sales objective (Society for HRM, 2005).

This essay will first start by providing some advantages and disadvantages of budgeting done in organization. Then the statements provided are discussed in the light of these advantages and disadvantages. In the final section, an organization’s budgeting procedure is critically analyzed and reviewed.

Before analyzing the statements regarding budgeting, the following paragraph provides some knowledge on the advantages and disadvantages of corporate budgeting.

The first and foremost advantage of budgeting is that is that it forms a link between the management and resources by compelling the former to think about the future of the organization so that plans are set out for each department to achieve the targets.

Secondly, budgeting is a source of communication from the top management to the department heads and managers about what is expected from them thus, promoting coordination between the two. Budget also serves as a yardstick with which actual financial performance is compared and measured.

When there is a variance then it promoted remedial action. It is a way of identifying resources and requirements and providing guidelines to the departments so that they proceed in the right direction. Managers are able to focus on the specific plans as outlined by the budget so that they can be achieved within the estimated time and resources.

When employees are given a chance to participate in the budget proposals then they become motivated and more productive. Proper budgetary planning can also ensure that resources are allocated productively, competitively and profitably resulting in cost reductions (Putra, 2008).

There are also various drawbacks and problems attached to budgeting within organizations. The first problem to budgeting is that it pressurizes the managers to achieve the targets forcing them to do gaming in order to take advantage of the rewards or due to the fear that the funds will be reduced.

Those managers can take the rewards that set for them easy goals but those managers can be penalized who set for them difficult but ambitious goals. Quality and customer service might deteriorate when the organization is striving to meet the budgetary targets and not the quality targets.

There are also bad labor relations due to budget pressures and conflicts arise between departments due to disputes over resource allocation and blames are thrown over each other when targets are not achieved. Due to budgeting managers sometimes overestimate the costs as well so that if there is any over expenditure then they are not blamed (Hope & Fraser, 2003).

 Recently organizations have turned against budgeting. This is because the forecast are very different from the actual results obtained at the end of the year because a business is subject to a lot of internal and external changes throughout the year.

With things changing so rapidly in the environment, nobody can closely predict what will be the position of the business after one whole year. At the end of the year it seems that planning and drafting the budget was a useless task and waste of time serving no purpose (Jensen 2001).

Top management is often not able to take right decisions when there seems an environmental opportunity due to planned budget constraints. They want to carry on the business according to the planned budget and therefore, overlook the opportunities available at some time in the year.

Few corporations have stopped this activity at all thinking that planning budget is a waste of precious organizational resources and time which can be spent elsewhere productively.

Non-profit or governmental organizations usually do not use budgets for their planning since such organizations do not work earning revenues and therefore, no planning is required (Whiting 2000). However, few non-profit organizations do plan their expenses so that they can arrange for the required amount of funds through charity or grants.

But there are some profit organizations as well who have realized with the passage of time that budgeting especially traditional form of budgeting is a waste of time and resources distorting decision making in fast changing environment (Merchant 1981).

Examples include Rhodia, a French global specialty chemicals company which dispensed budgeting entirely in 1999, Borealis, a Danish petrochemicals company which abandoned budgeting in 1995 and Volvo, the Automaker which also abandoned budgeting considering it as time consuming and waste of resources.

Budgeting is not common in smaller organization because they don’t know how to use budgets to plan their financial performance and goals (Rachlin 1999).

The article titled ‘Why budgeting kills your company?’ explains in a very concrete manner how budgeting actually consumes organization’s financial and human resources which could have been employed elsewhere productively (Gary 2003). It says that the average billion dollar company spends around 25000 person-days per year in drafting the budget whereas this could have been utilized in increasing the shareholder return.

Many organizations have begun to question the usefulness of traditional form of budgeting and are finding alternative ways for properly aligning the spending with strategy along with reduced time and resources (Bogsnes 2008). Today business of the entire world are facing tough times with the world economy in recession therefore, it is imprudent to justify increased costs for businesses due to budget planning (Schaumann 2007).

While planning the budget the top management is mostly seen in cutting expenses even if it is damaging the high-performing units while only sustains the underperforming ones. The resources are not allocated towards the high performing and deserving projects due to budget planning. Some experts believe that budgeting should be dispensed all together and decisions regarding it should be placed with the employees who are in direct touch with the customers.

The entire budgeting process takes a considerable length of time where first each department produces sales and capital needed forecast, then meetings are held to discuss the budget requests and for making the final decisions, budget books are produced after months of meeting and this all together can take around six months and 20% of the management’s time (Gary 2003).

Budgeting has become an expensive, time-taking and frustrating task for organizations because it is more like a fixed performance or implicit contract (Neely, Bourne & Adams 2003).

And the thing that worsens budgeting even further is that financial incentives like career prospects and bonuses are attached to such contracts if the goals are achieved.

Because of these financial incentives, managers and heads of department are pressurized to achieve the desired targets often resulting in distortion, misrepresentation and gaming on part of the most honest employees.

Managers become schemers since they put a proposal of 50% more than the required budget because they know that they’ll be argued down by the senior management to the desired level (Belkaoui 1994). Moreover, managers also start spending too much if their spending does not match the forecasted expenses due to the fear that if there is anything left over then their next year funding will be reduced.