This paper seeks to discuss how budgeting can impact organizational behavior. This paper explores how the impact can be both positive and negative and discuss ways that financial managers are changing the budgeting processes to better inform managerial decision making.
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Analysis and Discussion
Budgeting, its nature and purpose
Budgeting could be considered as the art of influencing or controlling operations (Hearn, J., et. al., 2006) by influencing management to work with targeted level of revenues and expenses and targeted levels of assets, liabilities and equity in the organization. Although the emphasis of budgeting is short-term, that is on a year to year basis, the effects on balance sheet accounts are necessarily included therein.
Since budgeted revenues and expenses are expressed via projected income statements it follows that certain level of revenues must be attained and that certain level of expenses must be kept within the budget. Budgeting may however be under fixed budgeting or flexible budget.
The positive and negative impact of budgeting on organizational behavior
The positive impacts of budgeting on organizational behavior are those that will help the company attain its corporate objectives since people particularly the managers are motivated to attain such objectives. Some of these possibilities are discussed in the following paragraphs.
Budgeting could result to more motivated managers if the goal congruence is attained in budgeting (Nutt, P. 2006). There is goal congruence if the managers are being properly led into producing according to well defined responsibilities under the budget with feature of properly rewarding managers which have performed accordingly using the budget.
A more proactive view of budgeting could use the same process to set targets to maximize long-term value (Gordon, J., 2007) and beat the competition, not the budget. Budget is in effect a way to put people guided by what management is set to attain in terms of its objectives. Budgeting could also be viewed as a strategy by devolving the strategy to front-line people while making the same continuous and not only a top-down event that should only be done annually the traditional way. By so doing, every member of the organization is a co-executor of the chief executive officer (CEO) in making sure that objectives are met. If managers are made to participate in the budgeting process, these managers would have the chance of being challenged as people to think critically and not incrementally. Since these managers would be made part of the decision making, there is greater chance that they would do their best to do their part in what roles they have been made aware in delivering the attainment of corporate objectives.
Managers when made part of budgeting would become stewards or responsible for resources on the basis of value creation over the lifetime of the investment applied by the corporation. They would have the change to see with the owners and enjoy the challenge of influencing variables that would contribute to the attainment of corporate objectives.
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Budgeting when properly used may involve measuring cost on the basis of their adding value and not merely making comparison with last year. If managers are thinking in a way where it is added value that will truly count, they would have a better understanding that making decision is not only thinking how much cost would be saved but that how better it would be for the organization as a result of making decisions.
Budgeting could also provide the needed positive impacts if it would be used to show leading and lagging indicators to measure performance not just as detailed historical reports. Budgeting could also result to positive impact if rewards are given to managers based on competitive performance and not on personal financial targets and where managers a given the freedom to act. To illustrate, flexible budget could possibly address the concern of changing conditions of the market in relation to the efforts of managers. If higher demand during the year will turn out to be higher than the actual projected level of operation, budgeting should not object of prohibit the same and this could be done by setting a more optimistic budget for the year. The budget is never meant to restrain business if demand warrants. If management really believes that the coming year will be that competitive, then it could always adjust so accordingly.
The negative impacts of budgeting on organizational behavior are those that prevent the company from attaining its real corporate objectives since people particularly the managers are not motivated. Some of these possibilities are discussed in the following paragraphs.
Budgeting could be viewed as way to tell people that they are failures since they could not even meet the targets set in the budget. This kind of situation would normally happen when manager has no part in part in budget preparation or if they are given part such would be minimal and their responsibilities are given to them as if heaven has given to them nothing but to comply.
Ask any accountant in the world and he or she will confirm that accounting information, which is essentially conservative, makes up the budget. In fact one accounting principle that has been there in the textbooks up to time is the so called principle of conservatism. One cannot blame the accountant for that kind of attitude since this is the very nature of the profession. If verbosity is attributed to lawyers, conservatism is for accountants. Hence the meaning of the word ‘accountability’ which connotes the meaning: ‘one must be able to explain what happened’. To explain what happed there must always a comparison versus actual and projected. What is actual is one that is supported by evidence of which accountants must ensure if they want to stay in their profession because that is one where they are really responsible. Managers on the other hand need not be accountant or think like accountant to be able to discharge their functions well. They are in fact expected to transcend that accountant’s view of business.
Budgeting involves understanding cost. There is a practice in business to create various geographical segments or different cost centers and profit centers in terms of responsibility accounting. Since each segment or cost center would be comprising costs that must be controlled by managers, sometime these managers are made responsible for allocated cost for purposes of measuring their performance. The allocated costs in terms of common costs are being deducted to evaluate the profitability of each segment or profit center. However, it could be found that allocated cost which is basically common to all segments or cost centers are done on the basis of revenue performance so that a segment with low revenue will necessarily have low share in allocated cost but higher revenue would have a higher share of allocated costs. If this policy is analyzed further, the same would discourage more revenue because of the higher share in allocated cost. This could result to lack of goal congruence in the whole corporate objectives, the segment objectives and personal motivations of the manager. It must be emphasized that budgeting is still involved here because of the computation of cost and revenues and the desire to control performance from each business segment.
How financial managers are changing the budgeting processes to better inform managerial decision making?
Budgeting process could properly be changed in a manner that could address the root cause of conflicts inside an organization. Under the agency theory (Gordon, J. 2007), it is believed that different stakeholders in business have different interests as may be found in the case of managers including the CEO as appointed or elected by the stockholders where the former would be considered as agents of the stockholders in attaining the latter’s desire to acquire more health. At another aspect, the ordinary employees are considered agents of the managers since they would have to carry orders also of these managers. In the nature of things, managers although appearing to maximize wealth of stockholders, would think first of their survival by ensuring the stability of the business in not taking higher risks for the business although it could make higher profits for the business. In addition these managers would try to build their empires in the organization by creating layers to the organization which may not necessarily efficient for the organization and where profitability is not maximized. To break this conflict of interest, the present practice of companies is to give stock options to managers and even to employees. If managers would become owners, they would be placed in a similar situation as the stockholders as their principal and this would definitely improve their behaviors towards the organization.
The same argument may be said for the employees who may just be inherently thinking as mere employees and therefore would have to maximize their salaries or wages while wanting to stay long with their employment by religiously obeying their superiors as employees. Making them as stockholders via stock option would definitely alter their behavior since they would now become part owners and their loyalty and commitment would take a more serious view. This would in effect lead them to behave as owners and when budgeting comes, they have the interest to be protected. They will then ensure that every revenue that must be earned and every dollar spent for expenses and cost of doing business.
Another good practice by the financial managers is via the participative budgeting as way to improve managerial performance. Financial managers could not be limited those in the private sectors. Those in the government or public sectors may also be considered to be using budgeting and its process to improve decision making and hence improve managerial performance. OECD (2008) attributes the need for better performance in the public sector due to tight budgets and demanding citizens are pressuring government managers to show good value for taxes paid. This in a sense equates to practice of providing better information to managers under present budgeting systems and thus serves as an effective tool for decision making and evaluating performance of managers.
In the same way that the companies in the private sectors are using, public sectors too are introduced to performance budgeting which has been found to have linkages to broader efforts to improve expenditure control as well as public sector efficiency and performance. Performance budgeting is therefore effectively combined with increased flexibility for managers in return for stronger accountability for results. This has the effect therefore of enabling them to decide about the delivery of public services (OECD, 2008).
OECD (2008) countries have confirmed the benefits of such performance budgets in terms of generating a sharper focus on results within government in addition to providing more and better understanding of governmental goals and priorities and on how different activities and programs are contributing to them.
This paper has discussed how budgeting can really impact organizational behavior and found that such activities on budgeting could have really positive or negative impact depending on how management may make use of the same. There are requirements for the effective use of the budgeting systems and processes in order to help attain corporate objectives. Failure to fulfill those requirements could make budgeting dangerous if it would result to lack of congruence in management strategy to attain the corporate targets and how manages should behave because of their nature as human beings with rational minds. This paper has clearly illustrated when budgeting could in fact become a de-motivator because of lack of congruence. Nothing could be more dangerous than working against human nature by making managers responsible for things of which they have no control. On the other had the budgeting process could be taken advantage to better inform managers for decision making by making them as partners of executive in implementing strategies that would ensure attainment of corporate objectives. The participation of management could extend up to seeing these managers how good it could be to reach these management targets as they would also be rewarded accordingly if they do their parts. The present practice of management include also giving stock options to managers and to employees so as to out a balance because of the inherent conflict among different stakeholders in the business based on the agency theory. Making managers as stockholders or at least giving them the options would lead them into believing that need not be working against the interest of stockholders by prioritizing their interest but they could behave as owners of the business themselves. This type of development of giving the managers the benefit of stock bonus or stock options could well be integrated under the budgeting process since everything that would involve the revenues and expenses of the projected financial statements are technically considered as integral part of budgeting. Employees who include the managers in broader sense when they are given the chance to own stock will be more than willing to change their inherent position or attitude as far as their employment with the company employing them is concerned. Nothing could be more motivating that one is working for the company that one partly owns.
Gordon, J. (2007) The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices; Stanford Law Review, Vol. 59.
Hearn, J., et. al. (2006) “Incentives for Managed Growth”: A Case Study of Incentives-Based Planning and Budgeting in a Large Public Research University; Journal of Higher Education, Vol. 77.
Loughry and Elms (2006), An Agency Theory Investigation of Medical Contractors versus Member Physicians; Journal of Managerial Issues, Vol. 18.
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Nutt, P. (2006) Comparing Public and Private Sector Decision-Making Practices; Journal of Public Administration Research and Theory, Vol. 16.
OECD (2008), Policy Brief, Performance Budgeting: A Users’ Guide, Web.