Many mid-sized and large companies are used to run their business activity based on a strict budget. The management often ensures that the organization allocates and spent money as dictated by the budget. The compensation system in such an organization is often tied to the ability of an employee to meet the stated amount in the budget when it comes to sales, production among other activities in an organization. However, the CEO of some companies have abandoned the traditional budget and let their business run on market trends, insight and what is referred to as “intuitive budget” where funds are allocated depending on the requirements at hand.
Be as it may, most managers prefer to control business costs and protect profits using a formal written budget. But such traditional budgets have some deficiencies that may limit organization from the optimization of performance. One of the limitations is that traditional budget limits the ability of an organization to minimize costs, improve its relationship with clients, come up with new products and respond faster to variations in the external business environment (MCGEE, 2003). Traditional budget brings about a strict commitment that prevents managers from making flexible decisions based on changes in customer mix and general business environment. The reason is that traditional budgets confine managers to invest resources according to the allocated amount that is not supposed to be exceeded.
Traditional budgets are also inflexible where departments perceive that if they don’t spend the money allocated to them, they are going to lose them. Therefore, department heads tend to use the funds allocated to them inappropriately just to exhaust the resources rather than considering if the spending generates revenue. Traditional budgeting also begot the cooking of figures by individuals working on the organization to meet or exceed budgetary goals so as to get compensation in the form of pay and bonuses.
Many organizations still use traditional written budgets because of their advantages. According to AJ Osborne, written budget encourages managers to think about the resource requirements of the different business activities of the company (MCGEE, 2003). Therefore, managers can make the right decision when it comes to allocating resources. The reason is that traditional written budgets enable managers to think of the financial consequences of the decisions they make. Therefore, it is helpful in helping managers to make decisions that are bound to bring more revenue while cutting down on cost.
However, the written budget is inflexible. The written budget presents a disadvantage when it becomes inflexible constraining managers to cling hard on the set budget. Managers who are confined to a set budget are often apprehensive and afraid of taking advantage of the emerging opportunities that are beyond the stated budget. Therefore, managers will not be in a position to optimize organization performance and generate more shareholder’s value.
The written budget presents a disadvantage because it leads to an inappropriate compensation system. The reason is that bonuses in an organization using a traditional budget are often tied to the ability of employees to meet targets as dictated out in the budget. This approach is ineffective because managers do not consider if such targets are achieved in a manner that is of the organization’s best interests.
Omgeo abandoned the traditional budgeting and replaced with what is referred to as “rolling forecast”. The organization still uses the traditional budgeting principles where the company and departmental goals, as well as resources, are allocated for the coming one year. Unlike the traditional budgets, the prepared budgets are reviewed monthly to account for any changes and trends in both the client mix and business climate (MCGEE, 2003). The company also changed its compensation system where employees are allowed to evaluate their achievements by meeting organization goals instead of meeting specific set objectives.
MCGEE, S. (2003). Breaking Free from Budgets. Inc.com. Retrieved 28 March 2016, from http://www.inc.com/magazine/20031001/breakingfree.html