Budgeting, A Tool From The Devil Or A Gift From Heaven

Abstract:

The question where this article is focusing on is why companies continue to use budgeting even though everyone says that budgets are bad. The article has been written on the base of four published papers on this subject. The quality of this article is therefore somewhat limited by the quality of the other four papers.

In this article we first examine the reasons why budgets are believed to be bad. This has several reasons but the most important reasons is because companies use budgets in their performance evaluation. This causes gaming by the employees and this also causes the large amount of time needed to complete the budgets. Due the these two facts the budgets are not very effective anymore in the planning and control process and therefore are considered bad. Next to the fact that the budgets are used for performance evaluation they are also outdated. The traditional budgeting process has been developed in the 1920's when the economy was fairly stable. Now, however, we are living in a fast moving world and therefore the budgeting process needs to be more flexible.

In the article we also examine the two movements that have been developed as an answer to the dissatisfaction with the traditional budgeting process. The movements are the ABB- and the BB-approach.

The answer to our questions is that budgets are not necessarily bad but that they are used for the wrong purposes, for example as a performance evaluation. However, even though the majority of people, that are working with budgets, are dissatisfied with them, they continue to use them. This can be explained by the fact that companies are afraid for changes. They have been using budgets for years and have become to see them as a routine. Next to this we also see that the budgeting process has to be adapted to the current situations.

Introduction

Budgets have for years been used by companies as a tool in the management control process. Throughout the years, however, more and more practitioners have been expressing their doubts in using budgets for the evaluation of the planning and performance. According to practitioners, budgets leave room for gaming by the managers who design the budgets and are evaluated according to the budget.

Throughout the years several papers have been written about the research on the effectiveness of budgets. Most papers recognize these downsides of using budgets within a company for planning and the evaluation of performance. Despite the negative notes that come from these researches companies continue to use budgets in their planning and performance evaluation.

The purpose of this paper is to evaluate whether budgets really are bad and, if so, why companies continue to use these budgets. The first part of the paper is a literature review of the literature that is used as a base for this paper followed by a short elaboration on the different usages of budgets. An analysis of the problems with budgets is then done followed by the usage of budgets in the performance evaluation. This is then followed by an explanation of the ABB- and the BB-approach and is then followed by an analysis of whether companies still use budgets. Finally, the conclusion will outline the answer on my main question: 'why, if budgets are that bad, do companies continue to use budgeting?'

Literature review

In the past years several academic studies have been performed on this subject and these have been published in well known and highly renowned journals. This paper is based on four publications about the research that has been done on this subject. Underneath you will find short summaries of these articles.

Hansen and Van der Stede (2004)

This article examines the potential reasons for budgeting within organisations. They have examined the importance and the performance of each of the reasons to budget using a survey which was send out to practitioners that were responsible for preparing the budget for their organizational unit. From all the replies to the survey, 57 replies were usable.

Hansen and Van der Stede decided to focus their research on four potential reasons to budget. These reasons are: (1) operational planning, (2) performance evaluation, (3) communication of goals, and (4) strategy formation. This list is primarily practice defined.

The research uses statistical data that is gathered form the survey to get information on the importance and performance of the four potential reasons to budget. They also investigate the origins of why organizations use budgets for a specific reason.

Jensen (2003)

This article examines the counterproductive effects that budgets and targets can have when being used in the performance measurement and compensation systems within an organization. The authors state that, when companies are paying people on how their performance is compared to a fixed budget or target, this causes gaming among the employees. The main purpose of the article is to show how gaming can arise and how this can be stopped.

Jensen shows with his article that budgets and targets should not be used in reward systems. These budget-based reward systems reward people for lying and rewards people for ignoring or destroying valuable information and therefore encourage gaming.

According to Jensen the solution to the gaming problem is not by eliminating the use of budgets but by eliminating the use of budgets and targets in the compensation and promotion systems. Jensen also shows that the use of goals will also result in lying even if their are no monetary rewards for meeting the goals

Dugdale and Lyne (2006)

The article examines the effect of the criticism on the use of budgets, that has risen from the research done on this subject, on the actual use of budgets by companies. The main question that they try to answer is whether this criticism has led companies to abandon the use of budgets.

To get an answer to this question, Dugdale and Lyne held a survey among the financial and non-financial managers in 40 companies to get an idea on how problematic they found their budgets.

The survey showed that al 40 companies in their research were still using