Text 9. What Are Budgetary Strategies?

A budgetary strategy is the manner in which a company approaches the budgeting process. The strategy adopted by the company impacts who is involved in the bud­geting process and how the budget numbers are derived. Each of the various budget­ing strategies is an attempt to minimize the motivational and behavioral costs associ­ated with budgeting. Two budgetary strategies that involve different groups of people are mandated budgeting and participative budgeting.

Mandated Budgeting Mandated budgeting relies on predetermined standards set by upper-level managers for its budget levels. It is also known as top-down budgeting because top management develops the budgets and passes them down the organiza­tional hierarchy to various divisions and/or departments without input from lower levels of management and employees.

The purpose of mandated budgeting is to set operating budgets that are in line with the goals and objectives of upper-level management. The predetermined stan­dards on which such budgets are based are estimates of the quantity and cost of oper­ating inputs and can be either ideal or normal. An ideal standard can be achieved if operating conditions are almost perfect; it does not allow for any operating ineffi­ciencies. A normal standard can be achieved under practical operating conditions and allows for some "normal" operating inefficiencies.

There is a great deal of debate among psychologists, behavioral scientists, and managers as to which standard is a better motivator for employees. Some profession­als think that ideal standards give employees something to aim for. Such ideal stan­dards are viewed as being motivational, whereas normal standards are thought to be too easily achieved and, therefore, not conducive to encouraging improvement. For example, if you could achieve an A in a course without studying, how motivated would you be to study? Employees also may be unmotivated by standards that are too easy to achieve.

Others think that ideal standards do not motivate because they are too hard to achieve, causing employees to give up. They believe that normal standards that can be achieved give employees a sense of accomplishment and, consequently, serve to motivate them. For example, if you felt as though you could not achieve an A in a course no matter how hard you studied, how motivated would you be to study?

Participative Budgeting Participative budgeting allows individuals who are af­fected by the budget to have input into the budgeting process. It is also known as bot­tom-up budgeting because the budgeting process begins at lower levels of the organi­zational hierarchy and continues up through the organization to top management. Upper-level management and the budget director are responsible for coordinating the information received from the employees and for developing a comprehensive budget plan.

For example, suppose that rather than having upper management determine the standard time allowed to produce a car, the production managers at Ford asked pro­duction employees for their input. Since the employees affected by the budget are given input into the process, this is a participative budget process.

Participative budgeting is most appropriate for divisions whose product lines are in the development or growth stages. In the development stage, the environment is particularly uncertain, and input from employees is necessary since they have a better understanding of the product than does upper management. In addition, employee input into the budgeting process may increase their motivation, which is essential to develop products and markets.

Since most companies have divisions in all the product stages from develop­ment to decline, the overall budgeting process is typically both participative and mandated. In these circumstances, employees have input into the budgeting process, the budget is revised by upper management after careful consideration of all employee input, and the final budget is prepared by the budget director and approved by the board of directors.

The second aspect of budgeting strategy concerns how to determine the budget numbers. Some companies begin a period's budgeting process by referring to the current period's budget, while others begin each budgeting period anew.

Incremental Budgeting Incremental budgeting is a strategy whereby the company uses the current period's budget as a starting point in preparing the next period's budget. The resource requirements of the current period are increased or decreased based on the changes expected during the coming period. The advantage of this strategy is that it is less time consuming and may involve fewer individuals within the organization. The disadvantage is that an increase in resource requirements is often proposed without considering whether the increase is really necessary.

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Zero-Based Budgeting In contrast, a zero-based budgeting strategy in which the company begins each budget period with a zero budget requires consideration of every activity undertaken by the department or segment. Rather than beginning with the current period's budget, the manager must determine if the activity is necessary, the alternative ways of conducting the activity, and the amount of resources needed to conduct the activity.

The advantage of zero-based budgeting is that it requires managers to carefully consider the activities undertaken by their respective departments and to determine if activities add value. The disadvantage of zero-based budgeting is that it is time consuming and, therefore, requires more resources than incremental budgeting.

Many companies have adopted a budgeting strategy that is both incremental and zero-based. In this strategy, a zero-based budget strategy is followed in a two- to three-year cycle with an incremental budgeting strategy in the intervening years. In this way, it is possible to obtain the best of both strategies.