Performance Management

Assignment Title: Analyse the extent to which you agree with this recent quote from the professional accounting press regarding the role of the traditional annual budgeting process

Budgeting was traditionally regarded as one of the most important management accounting techniques. However, since the 1980s there has been a significant change in the business environment where firms operate, such as the increased competition and a shift away from manufacturing towards services. Hence, a ‘beyond budgeting’ movement emerged in the 1990s advocating that the traditional budgeting process was no longer capable of meeting the demands of this new competitive environment, and even hindered companies improving their performances. Jarman and Bibekar (2009) even argued that ‘The downturn has rendered budgets agreed last year largely irrelevant’. It is the aim of this essay to critically discuss the validity of this statement with regard to the role of the traditional annual budgeting process.

The CIMA Official Terminology (2005) defined budgeting as a ‘quantitative statement, for a defined period of time, prepared and agreed in advance, showing planned revenues, costs, assets, liabilities and cash flows’. Budgeting is commonly used to help managers turn their strategic plans into action. It is valuable since it provides the yardstick to monitor whether things are going on as planned (Atril and McLancey, 2005). The traditional approach to budgeting, named as incremental budgeting, simply takes the existing level of activity and adjusting for pay and price increase or specific activity changes, for example, inflations (CIMA Official Terminology, 2005). It is relatively easy to conduct, but may lead to inefficiencies since it discourages reviews of the existing level of operations. Another budgeting method is called Zero based budgeting (ZBB), which originated from the United States that requires all costs to be specifically justified by the benefits expected (ibid). By contrast with the incremental budgeting, the distinct feature of the ZBB is that it requires managers to justify existing activities in exactly the same way as new proposals being performed for the first time. ZBB in general is a better budgeting method than the incremental budgeting because it not only solves the problem of inefficiencies, but also forces a wholesale review of operations and result in a more efficient allocation of scarce resources. Nevertheless, it is more costly and time-consuming, and likely to promote a short-term view towards budget-setting.

The world economy has experienced significant changes in the last two decades of the twentieth century. Globalization leads to more serious competition between firms, resulting in the popularity of privatisation and outsourcing. In addition, the focus of the economy has more and more shifted from manufacturing-based industries towards services industries with high technology and skills. Thus, the shortages of these traditional budgeting techniques began to emerge. Critics argue that the annual budgeting process is inflexible and therefore incapable of meeting the demands of the new competitive environment, and there is an increasing evidence of dissatisfaction with planning and budgeting process. Represented by Hope and Fraser, critics who advocate the ‘beyond budgeting’ movement claim that companies should abandon budgeting so that they can improve performance. Hope and Fraser (2003) have identified 10 criticisms towards traditional budgeting. For instance, budgets are regarded as time consuming and expensive, valueless, too rigid and focusing on sales targets rather than customer satisfaction so on and so forth.

The financial crisis sweeping the global economy during 2008 and 2009 further resulted in the debate of the usefulness of current budgeting process since our current budgeting system is unable to predict cash performance quickly and accurately. For example, one major FTSE 100 company declared a pre-tax profit of almost £1 billion in April 2008, claiming that the revenue growth rate for 2009 was 4%. However, By February 2009, the same company had reported a loss of £100 million for the nine months ending in December 2008, with expected losses of £150 million for the full year (Jarman and Bibekar, 2009). Critics question the validity of the 12-month budgeting given the economic downturn and volatility. Companies usually take more than three months to develop a 12-month budget, meaning that the budget is out-of-date by the end of the first quarter. Besides, the budgeting process can be rather costly. Jarman and Bibekar (2009) pointed out that on average companies devote eight full-time staff for budgeting for every £1 billion of company revenue, and the median process cost for budgeting and forecasting equals 0.05% of the total revenue.

Based on these criticisms, it seems that the conventional budgeting system should be abandoned. However in reality, it is still alive. Dugdale and Lyne (2006) conducted a survey about the budgeting practices among 40 companies and found that all of them continued using budgets. Managers, especially financial managers (about 95%) regarded budgets to be important for planning, control, performance measurement, coordination and communication. Moreover, most managers in general disagreed with the statements criticising budgets. Only 2 out of 20 critical statements were accepted by them (ibid). According to their study, there was a Finnish company which realized the shortages of its budgeting system. However, rather than totally abandoning budgeting, it introduced new techniques such as rolling forecasts and a more integrated method of budgeting such as the balanced scorecard.

Hence, the appropriate way to respond to the financial crisis is not giving up budgeting at all. Instead, we should turn traditional annual budgeting process that is profit-and-loss-based in to a more frequent, flexible and ongoing scenario-based continuous budget (Groves and Genever, 2010). It is a budget that is continuously updated by adding a further accounting period (month or quarter) when the earliest accounting period has expired, and is particularly useful during a period of high inflation when future costs are difficult to forecast accurately (CIMA Official Terminology, 2005). In other words, once the actual performance for one quarter becomes available, the forecasts of next three quarter will be updated immediately and the budget for the fourth quarter will start afresh (Jarman and Bibekar, 2009). The following figure shows the difference between the annual budgeting process and the rolling forecast process. Jarman and Bibekar also suggested a five-step process to change from annual budgeting to rolling forecasts. First, companies need to align their organisational strategy, long-term planning and targets with the budgeting process. Next, the budgeting process is simplified by reducing the number of budget iterations, budgeted lines and versions as well as the time taken to budget. Once the process has been simplified, the next step is to automate it by utilising the latest budgeting software. Thus, the company is ready to introduce the rolling forecasts. When the rolling forecasts are fully established, the annual budget can be eliminated.

In conclusion, I partly agree the statement raised by Jarman and Bibekar (2009) since to some extent the traditional annual budgeting process is unable to accurately estimate the future cost activities in today’s competing environment, especially after the financial crisis. However, budgets still can play a big role in a variety of functions. Hence, instead of abandoning budgeting practices exclusively, companies are recommended to adopt a new continuous or rolling forecast process which emphasizes continuous updating and is able to better forecast the impact on the cash position. It is also important to understand that rolling forecasts are not a panacea for ever business, and companies thereby need to develop the budgeting system based on own internal resources and external challenges.



Atril, P. and McLancey, E. (2005). Management Accounting for Decision Makers (4th Edition). United Kingdom: Pearson Education Limited

Dugdale, D. and Lyne, S. (2006) Budgeting practice and organisation structure. CIMA Research Executive Summaries, Volume 6, Issue 4.

Groves, N. and Genever, A. “Budgeting after the crunch”, ACCA Accounting and Business, May 2010, pp 40-42.

Hope, J. D. and Fraser, J. R. T. (2003) Beyond Budgeting: How Managers Can Break Free from the Annual Performance Trap. Boston: Harvard Business School Press.

Jarman, N. and Bibekar, S. “New era budgeting”, ACCA Accounting and Business, July 2009, pp 46-47.

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