Budgets are not worth their costs
The budgeting process is extremely long to implement: it is not rare for it to start in April of a year to barely finish on time for the next. It is time consuming and often frustrating as managers may have to revise their plans several times. This naturally brings the following question: are the benefits of budgets worth their costs?
Many managers happen to doubt budgets are worth what is invested in them, especially in more turbulent environments. In such environments, the forecasts on which budgets are built are often obsolete even before budgets are completed. This rapid obsolescence calls for periodic reviews and reappraisals (usually every quarter) which add to the workload and the frustration.
Budgets foster inertia
To reduce the workload, managers often implement incremental budgeting which consists in basing the amounts budgeted for discretionary costs on the amounts spent during the previous period, sometimes applying a slight increase or decrease.
Such an approach saves time as it does not require an elaborate justification based on organizational goals; but it also fosters inertia and a mechanical renewal of past expenses, even when they have become unnecessary. Indeed, past performance can incorporate sub-standard performance or often relate to different economic conditions.
This inertia is accentuated by the fact that budgets are set once for the year. Once established, they create rigidity and stifle creativity as the goal becomes to meet a budget defined a long time ago. An excessive emphasis on meeting the budget under all circumstances diverts managers’ attention away from unexpected (and therefore not budgeted) opportunities.
Since budgets artificially force forecasts (where the firm is going) and targets (where the firm should go) to be the same, they cannot anticipate discrepancies between the two trajectories. Discrepancies can only be diagnosed after the harm is done, with variance analysis.
Finally, instead of a tool for thinking about goals and strategies, budgets can also sometimes be used to rationalize and justify courses of actions which have already been decided. It becomes a legitimization tool and the lack of real critical scrutiny prevents budgeting from serving the very functions it is supposed to serve.
Budgets foster dysfunctional behaviors
All the prior issues are further aggravated by the high stakes associated with budgets. Indeed, budgets influence resource allocation (who controls organizational resources) and performance evaluation (who gets rewarded and promoted). This makes budgets highly sensitive and fuel intense political struggles and dysfunctional behaviors within organizations.
Rewarding managers for meeting budget’s objectives can be a very powerful tool to ensure that strategies are properly implemented, but as discussed earlier it also forces a lock-in and fosters inertia. Perhaps even worse, it provides managers incentives to lie twice.
First, budgets are sometimes used to pressure and blame employees. As a consequence, they can become a source of mistrust, hostility, tension and conflict between managers and between managers and their subordinates. Managers have thus an incentive to underestimate the performance they can achieve to negotiate easier targets. This tendency to build slack by providing inaccurate information about organizational capabilities is known as padding or gaming the budgeting process.
Budgetary slack results from managers’ tendency to underestimate expected sales or overestimate budgeted expenses so that they are more likely to meet their objectives. Budgetary slack hedges against unexpected adverse circumstances.
Second, managers may also have later an incentive to misreport (overstate) actual performance to earn their bonus. This further degrades the quality of the information on which estimates are built, and therefore the quality of the decision made based on these estimates.
These strong criticisms against budgets naturally raise the following question: if they are that bad, why are they still everywhere? Why do managers keep investing so much time and effort in the budgeting process? Some argue that budgeting is a useless ritual that organizations maintain out of habit. But more probable reasons are that 1) the absence of budgets may be even worse and 2) many criticisms do not address intrinsic flaws of budgets themselves, but flaws in the way budgets are implemented and used. This has led to many propositions to improve budgeting.
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