Under traditional budgeting, the master budget is the “formal outline
of the company’s financial objectives and how they will be attained.”
(Datar & Rajan, 2018, p. 225) Budgets are a tool for determining if
managers and employees are on target for their growth and spending
goals. Financial budgets quantify managers’ expectations regarding a
company’s income, cash flows, and financial position. They are
developed using supporting information from nonfinancial budgets
like units manufactured or sold, number of employees, new products
being introduced. They are most effective when integrated with the
company’s strategy so that capabilities are matched with
marketplace opportunities to meet objectives. (Datar & Rajan, 2018,
p. 198)
ADVANTAGES OF TRADITIONAL BUDGETING
There are four main benefits to traditional budgets. They promote
strategic analysis and planning. They help managers to communicate
expectations to different departments or divisions and coordinate
efforts. They give a metric to assess performance by measuring
actual performance against predicted performance. Budgets also help
manages motivate themselves and their employees (Datar & Rajan,
2018, p. 200)
CHALLENGES OF TRADITIONAL BUDGETING
Budgeting is a lengthy process that uses a great amount of resources.
The budget process is time consuming. It is estimated that senior
managers spend 10-20% of their time on budgeting and financial
planning departments spend as much as 50% of their time. (Datar &
Rajan, 2018, p. 201) Effective use of budgeting requires
understanding and support of the budget at all levels.
It is important to understand that meeting the budget is not the goal;
using the budget to meet the company’s goals is. This requires
flexibility and responsiveness to changing situations (Datar & Rajan,
2018, p. 202). Traditional budgeting can create issues when budget
variances are used to evaluate performance resulting in people
playing the budget by underestimating budgeted revenues or
overestimating budgeted costs (Datar & Rajan, 2018, p. 220)
According to Rygelski (2018) the biggest disadvantage to traditional
budgets is that they are based on past information and assumptions
about the future and are inflexible. Companies either stick to a
budget regardless of circumstances or they constantly make changes
so the budget just ends up reflecting actual performance. Traditional
budgets can contribute to lack of critical thinking and lead to poor
decisions made to avoid going over budget or to avoid losing
budgeted money in the future by spending to their allotted budget.
Rygelski (2018) suggests that creating 13-week cash flows as an
alternative to traditional budgets because they are easier to keep
updated, provide a better depiction of the state of business to make
decisions, and they replace budget with a dynamic planning process
that includes questioning and discussion around financial decision
making
A compromise to static, traditional budgets is using budget data are
frequently revised as the year goes on (Datar & Rajan, 2018, p. 202).
Use of a rolling or continuous budget makes information always
available for a set future period by adding to the period just ended.
Budgetary slack can be reduced by providing richer information more
frequently, by using the budget for planning and not for performance
evaluation, or by provide stretch targets (Datar & Rajan, 2018, p.
221).
Datar, S. M., & Rajan, M. V. (2018). Horngren's cost accounting: A
managerial emphasis, global edition, 16/E 12. PEARSON EDUCATION
LIMITED.
Rygelski, M. (2018, January 5). Council post: Budgets don't work: Here's
how businesses can do it differently. Forbes. Retrieved May 26, 2022,
from https://www.forbes.com/sites/forbesfinancecouncil/2018/01/
05/budgets-dont-work-heres-how-businesses-can-do-it-
differently/?sh=c95e50c46b8a
