Budgeting

Co-ordinataion Responsibility Utilization Motivation

BUDGETING
Planning Evaluation Telling

Traditional Budgeting

T Y P E S

O F
B U D G E T

The budget for the period is prepared by adjusting the previous periods budget (or actual results if available).
ZBB aims to eliminate non-value adding activities by evaluating the costs and benefits of each decision package. ABB is a technique used to budget that focuses on the cost of activities rather than assuming that costs increase in direct proportion to output.

Beyond Budgeting
Beyond budgeting advocates argue that management is motivated only to meet the budget and may do things that are not in the long term interest of the business. What is it? The general principle is that an organization should not program its activities in the form of a rigid plan locked into an annual cycle. In place of fixed annual plans and budgets that tie managers to predetermined actions, targets are reviewed regularly and based on stretch goals linked to performance against world-class benchmarks, peers, competitors and prior periods.

Questions (September 2010)

A college is preparing its budget for 2012. In previous years the director of the college has prepared the college budget without the participation of senior staff and presented it to the college board for approval. Last year the college board criticised the director over the lack of participation of his senior staff in the preparation of the budget for 2011 and requested that for the 2012 budget the senior staff were to be involved. Required:

Discuss the potential advantages and disadvantages to the college of involving the senior staff in the budget preparation process. (Total for Question Three = 10 marks)

Answer There are potential advantages and disadvantages of the involvement of staff in the preparation of the budget . Potential advantages include: Involvement would encourage senior staff to be motivated to achieve the target because they would take ownership of it as their budget. Senior staff may have a better knowledge of individual courses and how they may be delivered more efficiently and cost effectively. They would also have a better understanding of how to attract more students to the course thus increasing its profitability. This would improve the accuracy of the budget. Senior staff would feel that they are being respected for the value that their experience brings to the running of the college.

Potential disadvantages include: Senior staff may be excellent academically but could lack the knowledge and skills required to formulate their budget and to work together to form the budget for the college overall.

 Senior staff may spend a great deal of time arguing with each other (and with the college director) as to how to measure the benefits of a particular course and how the cost / benefit analysis of each course should be compared. Senior staff may agree among themselves to include unnecessary expenditure (budgetary slack) so that it is easier for them to achieve the cost targets they have set. Senior staff may underestimate the expected revenue in order to make their final target more achievable. The participative process can be very time consuming, thus delaying the availability of the budget for the forthcoming year.

Question ( May 2010)

A firm of solicitors is using budgetary control during 2010. The senior partner estimated the demand for the year for each of the firms four divisions: Civil, Criminal, Corporate, and Property. A separate partner is responsible for each division. Each divisional partner then prepared a cost budget based on the senior partners demand estimate for the division. These budgets were then submitted to the senior partner for his approval. He then amended them as he thought appropriate before issuing each divisional partner with the final budget for the division. He did not discuss these amendments with the respective divisional partners. Actual performance is then measured against the final budgets for each month and each divisional partners performance is appraised by asking the divisional partner to explain the reasons for any variances that occur. The Corporate partner has been asked to explain why her staff costs exceeded the budgeted costs for last month while the chargeable time was less than budgeted. Her reply is below: My own original estimate of staff costs was higher than the final budgeted costs shown on my divisional performance report. In my own cost budget I allowed for time to be spent developing new services for the firms corporate clients and improving the clients access to their own case files. This would improve the quality of our services to clients and therefore increase client satisfaction. The trouble with our present system is that it focuses on financial performance and ignores the other performance indicators found in modern performance management systems. Required: (a) Discuss the present budgeting system and its likely effect on divisional partner motivation. (b) Explain two non-financial performance indicators (other than client satisfaction and service quality) that could be used by the firm.

Answer to (a) The senior partner seems to want to involve the divisional partners in the budgeting process by inviting them to prepare cost budgets for their respective divisions. However, since they are then amended without any consultation it is clear that the divisional partners do not have any real involvement as they are not able to influence their final cost budgets. From a motivational point of view this approach is probably worse than not involving the divisional partners at all. They will feel that they have wasted their time in preparing a budget which is then effectively ignored. The benefit of involvement leading to ownership of the budget and thus feeling personally responsible for achieving the target costs is therefore lost. Divisional partners will not be motivated to achieve the budgeted cost. Indeed they may be motivated to deliberately fail to achieve the budgeted costs in order to prove that their own budget was correct and that the changes imposed by the senior partner were wrong.

Answer to (b)
A number of non-financial performance indicators could be used by the firm. These include: Number of training days for staff and partners which is used to measure the investment by the firm in its people and the firms commitment to providing up to date and current information to its clients. Response time between the enquiry and the first meeting with a client which is used to measure the efficiency and flexibility of the firm to meet client demand.