The objective of this essay is to critically evaluate the effectiveness of budgetary control in an increasingly unpredictable environment. We will start with a brief introduction to management control systems and explain what budgetary control is and how it fits in the general framework of planning and control within management control systems. Then we will move on to the advantages and criticisms of this system. After understanding how budgetary control works, we will then move on to analyze how effective budgetary control is in today's rapidly changing business environment and how that affects the usage of this system of control.
We can all agree on how dynamic and complex the business environment is, but this shouldn't stop organizations from setting goals and achieving them. Organizations need to use their skills and management practices to plan and control their activities. Let us try to understand what controlling means and the different ways an organization can control its activities and obtain the desired results. Colin Drury in his book provided a good and simple differentiation between ‘controls’ and ‘control’. He stated that ‘controls’ simply refer to various measurements and information whereas ‘control’ is the function of doing what needs to be done to achieve the desired output or behavior. Therefore ‘control’ is the activities conducted to make sure that actual work is performed to achieve the goals and ‘controls’ are used to provide the information required to assist those control decisions. ‘Management control systems are basically a combination or a set of all the different kinds of control systems used by an organization. Different kinds of management control systems are Action (or behavioral) controls, Personnel social and cultural controls, and Results (or output) controls (Drury, 2018).
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Results (or output) controls refer to collecting and reporting information about the output to the managers to make informed decisions. In this system, managers rely on performance reports to analyze if the output is as desired or not. These reports tend to usually be defined in monetary terms such as return on investment, revenues, profit, cost, etc (Drury, 2018). One such form of results control is ‘Budgetary control’. Within the general framework of strategic planning and control, the budgeting control process refers to comparing the actual result with the planned output and taking decisions to respond to any deviations from the original plan. A budget is a kind of forecast of the revenue and expenditure in the future period, and it is one of the important components of the management control system.
As observed by Carr and Joseph (2000), budgetary controls allow the supervisory group to make arrangements for the future by executing those plans and observing activities to see whether they correspond to the arrangement. Effectual implementation of budgetary control is a significant assurance for a company. The budgetary control system aims to set the company's targets as a whole and make concerted efforts for its accomplishments. It assists in maximizing the profits of the company. To implement this goal, the organization needs to undertake appropriate coordination and planning of different activities, such as reasonably utilizing the company’s capital, monitoring revenue performance, and controlling expenditure usage control over various capital and revenue expenditures. It improves the company's entire efficiency by avoiding most of the wastage of resources. However, tight budgets may lead to oversight and errors occur, the budget may be overrun due to the cost of the product or service will be high in order to satisfy every department's requirement. Price advantage is likely to be lost which might lead to a negative impact on its profitability. As a result, managers may only focus on how to increase profitability regardless of the factors which are considered vital to their colleagues. In 2019, the crash of the Boeing 737 Max caused 339 casualties, another Boeing 737 aircraft crash occurred in the same year, where both investigations reported that the accidents were caused by technical issues. An investigation (ForeignAffairs, 2019) shows that there is a conflict between engineers/pilots and managers in the aviation industry, in which engineers and pilots concern more about safety and practical aspects whereas managers want to maximize the profitability of the company. Moreover, the Federal Aviation Administration has been charged as they empowered Boeing to do its own work in order to reduce its budget.
The principal concept of the budgetary control system underlined the procedure which leads management’s attention to the deviation between budgeted and actual performance (Ernest I., 1966). By setting various goals for different divisions, budgetary control offers an instrument for determining managerial performance. The budgeted goals will be compared to the practical outcome, and differences will be measured. The result of each division will be reported to the senior management. Therefore, the budgetary control system enables them to adopt corrective measures in case differences in performance occur. The performance differences are reported to the management team regularly; thus, they can employ necessary measures in advance. But since it is very difficult to predict the future of business in an increasingly complex business environment, the budget set at the beginning of the period will need to be amended multiple times if the business environment has changed and requires changes. Such frequent amendments to a budget will cause ambiguity to subordinates (Abernithy and Brownell, 1999). Besides, the budgetary control system may cause budgetary slack, which is caused by managers negotiating with the budget setting (Rodríguez and Gil, 2016). In a loose budgetary control system, managers will not frequently investigate the reasons for deviation, or only investigate when something significant is omitted. Under the system, the high standard deviation of budgetary slack will lead to a positive budget deviation, namely, the budget has been overrun. By contrast, a tight budgetary control system can lower, or even negatively, the budgetary deviation (Corboy, 2017). However, in a tight budgetary control environment, the workload for both middle and top managers is high, the relationship between superior and subordinate is low, cost of management will increase due to augments in audit review frequency. It requires managers' zeal for their jobs as well as high coordination in different departments, otherwise, the whole budgetary system may be collapsed.
Due to the rapid development of information technology, enterprises have access to “big data” which can be used to plan and control their activities effectively to ensure maximum efficiency. The business environment is being more and more unpredictable and complex nowadays, which causes budgetary control to become more critical to an organization. But the unpredictability of the business environment and unstable background makes it very difficult for enterprises and individuals to forecast future income and expenditure figures. This can affect the effectiveness of budget control, and H. Mao, S. Liu, and J. Zhang indicated that a high degree of environmental uncertainty requires organizations to use more reliable technologies and management methods to gain a competitive advantage.
Especially in 2020, according to BBC news (Simpson, 2020), 6,001 shops closed in the first half of 2020 due to the COVID-19 lockdown, which is twice as many compared to 2018 and triple of 2016. The reported figures only included retail, hospitality chains, and services such as post offices and banks, but it does not include small independent companies. The facts stated the importance of budgetary control to a business. An effective budgetary control strategy can increase the chance of a company being survived during any unexpected situations. The company can adjust its budgetary policy according to its performance and future expectation. The budgetary control system leads a company from employing an unfounded budget strategy to following a well-planned route towards the final goals.
Through reading a number of relevant literature reviews, the overall idea that there is no universal best budgetary control for all situations in any organization is consistent throughout. When implementing budgetary control managers have to consider various situational factors to ensure their budgetary control is employed effectively. Factors include: ‘the differences in the structure, stability, size, growth, competition, regulation of the industry, production or service process complexity, technology, routineness and employee skill (K.A. Merchant, 2007)’. Although this list may appear long on initial reading it is somewhat incomplete thus highlighting the complexity of the business environment. If managers fail to consider one of these factors it can make the difference between an effective and a substandard budgetary control.
The evolution of budgetary control has been a result of the evolving business environment. It wasn’t until 1932 that the first British text devoted to the topic was written: A.W. Willsmore’s ‘Business Budgets and Budgetary Control’ (C.S. Chapman, 2007). The environment in which Willsmore operated is vastly different from the one managers face now. In 1932 ‘there was effectively zero uncertainty due to the predictability of consumer demand, low levels of competition, and low levels of product differentiation (K.A. Merchant, 2007)’. This environment allowed them to standardize processes and make all decision-making centralized; opposite to today’s environment. Businesses are experiencing rapid rates of change in technological, social, and political aspects. The process of budgetary control can no longer be left to senior executives, but rather the responsibility of line managers. Line managers are now required to be agile in responding to changing consumer demands; challenging the traditional organizational structure, with line managers holding greater influence in decision making. This is supported by Child who concluded that ‘organizations who follow a centralized structure have ineffective budgetary controls (Child, 1973)’. Therefore, the success of budgetary control depends on the effectiveness of line managers to interpret the current environment.
A key emerging issue arising in the current environment for businesses is the significance of internet technology and ‘big data. Information technology is starting to become a huge part of everything we do include how businesses operate. ‘Globally produced data doubles about every 18 months, with data volume processed by organizations expanding by 35-50% per year (Bhimani, 2015)’. Through the rise of ‘big data’ new possibilities arise for organizations to increase the effectiveness of their control systems, the data available is so extensive it creates new business intelligence. Organizations can use this data combined with new technology to improve the accuracy and flexibility of their budgetary control. By harnessing the ‘growing sophistication of analytical methods and the lowered costs of information processing (Bhimani, 2015)’ organizations shape a deeper insight and understanding of consumer demand. The collection and analysis of ‘Big Data’ can reduce the effects of uncertainty within the modern business environment by propelling the effectiveness of budgetary control. Therefore, recognizing the value of ‘big data’ and employing intricate analysis of such information is key to the effectiveness of budgetary control within our complex and unpredictable environment.
Considering the criticisms of budgetary control by many writers such as Hope and Fraser (2003), Dugdale and Lyne conducted a survey in 2006 involving 40 UK companies to find out if budgets are still used by companies considering the criticism it attracts. What they found out was all the companies within the study still used budgets and the managers stated they find it very important in planning and controlling (Dugdale and Lyne, 2006). Another similar study was conducted by Ekholm and Wallin in 2000 where they surveyed 168 Finnish companies and found that very few companies from the study were planning to abandon budgetary control though most of them agreed with the criticisms that the system attracts (Ekholm and Wallin, 2000). A more recent study was conducted by Libby and Lindsay in 2010, where they looked into budgeting activities in North American companies and found that budgeting still plays an important role in control systems, and only 5 percent of the 558 companies surveyed considered abandoning budgeting. But they also noticed that many of these companies were trying to overcome some of the common criticisms. Companies were revising their budgets more frequently than expected and allocating resources outside of the budget to respond to rapid changes in the business environment. Very few organizations used budgets as a fixed performance contract, instead considerations and allowances were made for uncertainty in the business environment when evaluating performance. They concluded their study by saying most companies found ways to improve budgeting processes and the criticisms are exaggerated (Libby and Lindsay, 2010).
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