Accounting departments have formalized the process of budgeting over the years, and during that time, the practice evolved into the annual budget process. This process is largely based on assumptions and predictions about future markets and expenditures. The effort to control operations through a framework of guessing what "might" happen has resulted in multiple perceived disadvantages. Learn about the criticisms that come from these perceived drawbacks of annual budgets and whether annual budgets should be eliminated.
1. Assumptions Lead to Inaccuracies
No one can predict exactly what will happen in the future, but many business professionals make the attempt in the form of the annual budget process. Although learning from the past might seem like a good prediction of the future, economic, regulatory and environmental changes can drastically affect accuracy. Some of these factors include:
- Reduced revenue
- Increased costs
- Variances in interest rates, exchange rates and commodities
One of the criticisms of these inaccuracies is the inability to quickly make adjustments. Companies that don't allow budget overrides fall prey to spending that's no longer supportable.
2. No Provision for Flexibility Reduces Efficiency
Companies often rely on bookkeeping strategies that only focus on the end of the fiscal year. Instead of taking a proactive stance and pursuing year-round analysis, budget discussion is saved for the last few weeks. Department heads compile compulsory numbers including sales forecasts, profits and capital expenditures that are handed to high-level executives. The C-suite looks it all over, discusses it and finalizes the plan without further input. Limiting the analysis time to one single time period also distorts projections because the information used is outdated when it's actually put to use. This kind of rigidity results in a lack of provisions for considering strategies during the rest of the year, which could counter problems at the time they occur or even eliminate them beforehand. The company then becomes susceptible to budget crises or market changes.
3. The Annual Budget Process Consumes Too Much Time
Creating a budget is time-intensive, sometimes taking up to six weeks for the entire accounting staff. During the process, many of the other bookkeeping duties don't receive the attention they deserve. According to CFO.com, regardless of company size, 49 percent of the finance department's time is spent paying bills. If their time is taken up with devising a budget during those final six weeks of the fiscal year, that's nearly three weeks of bills not getting paid. When they do return to their routine functions, more mistakes occur, which in turn adversely affect the budget that was set. This affects cash flow in both the immediate and future time frames of the company's operations. If the company opts for outsourced bookkeeping services, it could avoid these time crunches and delegate resources to better serve the organization.
4. Strict Budgetary Guidelines Create Budgetary Slack
With strict budgetary guidelines, managers may try to manipulate their departmental budgets by over-inflating their expenses and reducing expected revenues. This slack, also called "sandbagging," occurs in up to 80 percent of large corporations. Managers may also use other manipulation, such as:
- Deferring expenditures to the next year in order to reduce costs for the current fiscal year.
- Moving anticipated sales to the current year to inflate revenue.
- Incurring expenditures during the current year in an attempt to increase the following year's budget.
5. Use-It-or-Lose-It Policies Destroy Accountability
This annual budget process strategy determines a department's budget based on yearly expenditures. Some corporations try to control operations through decreasing budgets when all of the money isn't used. This means if the money isn't spent, the department may lose it from the following year's budget. This process destroys accountability because managers tend to approve extravagant spending at the end of the year in order to use funds so they won't be lost from the next budget. Between 40 percent and 80 percent of all businesses suffer from this mentality. In the long run, these companies lose profit to unnecessary spending and poor planning.
6. Focusing on Financial Outcomes Distances Customers
Corporate finances rely on the computation of numbers, but often the numerical values aren't necessarily correlated to the value of obtaining and maintaining the customer base. Consumers rarely consider the costs incurred by companies; they merely want the best deal and quality service. These qualitative values may be very different from the quantitative values assigned to profit by executives. When focusing on numbers alone becomes the standard, relative targets that push employees to succeed are diminished.
7. Expense Allocations Cause Internal Turmoil
Overhead budgets allocated to internal departments aren't always the most frugal choice. In an attempt to keep things in house, this type of budget decision can cause strife with managers who would rather save money or build relationships with vendors. Likewise, allocations made for only pre-approved vendors can also create turmoil internally. When department heads know that budgets could be spent more wisely at different venues, they lose faith in the system and are more likely to bend the rules in other areas of the budget.
These drawbacks are cause for concern, but ultimately every organization must make its own decision whether or not to abandon the annual budget process. Criticisms will always abound, especially for those who desire to shake up the system. You may not be able to see into the future, but you can decide to change the processes that no longer benefit your company.