budget criticism
Budgets are often criticized for controlling the wrong things or creating pervasive incentives when used in performance reviews. Critics often overlook the various benefits of budgeting and the budgeting process, but that doesn’t mean the criticisms are totally unfounded.
Budgets facilitate decision control and can be used as benchmarks to measure performance. Specialized information is collected from lower levels of management to higher levels and can be used as an indicator of actual performance. Upper-level management can use the assumptions made during the budgeting process as performance measures for budget owners. The budgeting process in large companies is the orchestration of specialized knowledge from numerous departments.
The executive team sets goals for the coming year based on past performance and current or expected economic trends. The marketing team builds its budget based on the marketing campaigns that will be used to achieve the goals. Operations departments build their budgets based on the expected volumes resulting from marketing campaigns. This transfers the specialized knowledge of the marketing department to the operations departments through the budgeting process, with both departments using their specialized knowledge to create their own budgets. Executives then review the bottom-up budget against the prior year’s performance.
Sometimes the executive may request a 5-10% reduction in budget dollar amounts offset by a corresponding increase in productivity or other cost reduction in a reverse ratchet effect. In effect, reducing the budget instead of increasing the budget based on a constant level of productivity. The executive leaves the decision of how to achieve the increase in productivity to the lower levels of management that are closer to the process. These decisions are made with knowledge of the current business environment and should be made after careful deliberation so that they do not set unreasonable or unattainable goals that could discourage lower levels of management.
Budgets provide control of decisions in terms of spending, but often companies go a step further in using accounting for control by requiring that actual spending be approved by higher levels of management than actually incurred. incurs the budgeted expense. A more efficient process allows routine processing of budgeted expenses, while the total amount of the expense is monitored on an annual or monthly basis. If an operating manager is responsible for a process that incurs a regular expense, then he has the authority to spend the budgeted dollars used in that process. If a manager is responsible for processing credit card applications, their information is used to produce a budget for that expense. If the CEO has approved the budget that contains a regular expense of $120,000 per year or $10,000 per month, but the company has a policy that requires all expenses over $7,500 to have prior approval from the CEO, do you have Does the CEO approve the monthly budget? expenses every month? It would be more efficient to approve the spend once in the budget and control the volume of the budget cost driver.
Criticisms of budgets generally refer to how the budget process is used rather than a direct criticism of the budget process itself. The budget process does not require that the budget be used in performance evaluation. If the budget controls the wrong things, this could indicate a problem in the way the budget was created, not necessarily in the budget process itself. It is usually a criticism of misallocation of costs.
