The main purposes of traditional budgeting

Traditional budgeting is argued to have begun about a century ago as a method of managing costs and cash flows. Typically, the process’s steps are as follow:

• Prioritising objectives identified in the corporate financial planning process
• Assessing and quantifying total available resources, both financial and non-financial 
• Identifying and quantifying the inputs and processes required to fulfill the stated objectives and the associated financial resources required
• Assigning proportion(s) of the total resources necessary to acquire/manage inputs and achieve the stated objectives

(Source: CIMA)

In a perfect world, the three main purposes of traditional corporate budgeting are:

1. Coordinating the company’s financial activities and presenting an overall picture

A budget is comprised of all financial elements of an organisation, from individual units to divisions and departments. Ultimately, it depicts an overall picture of the organisation’s operational objectives and strategic goals.

Budgeting is not merely about profit planning. It is about aligning the individual units with the organisation’s strategic and operational goals. Moreover, budgeting is about allocating resources so that senior management can make decisions about savings and revenue objectives. It is important to note that managers are supposed to consider their operations in relation to those of other departments. This ensures that no one is treading on each other’s paths.

2. Communicating financial plans to those held accountable

Individuals are supposed to report to those, known as budget centres, held accountable for the outcome of departments or teams. This is defined as “a section of an entity for which control may be exercised through prepared budgets” (CIMA, 2005). Hence, a budget is designed to give decentralised managers a firm understanding of the organisation’s financial plans, from expected cost savings to targeted revenues.

However, since the traditional budgeting system has evolved toward higher levels of detail, it has given way to centrally controlled, bureaucratic leadership. The fact that budgeting occurs only once a year, and the adjustments needed to adapt to changing market conditions are hard to implement, only deepens the bureaucratic culture in decision making. 

3. Motivating individuals to act in the organisation’s interest

Since budgeting provides the authority for expenditure, key individuals can use this power to achieve challenging objectives and get rewarded. Nonetheless, this is the most debated function of budgeting, as dysfunctional behaviors may occur.

For example, a manager can spend all the money that remains at year-end to avoid having an allocation cut the following year. Or this manager can deliberately submit a larger-than-actual budget proposal in order to receive credit for meeting this easier goal.

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