Budgeting is one of the most important concepts in modern business and economic activity and the backbone of all scales of financial management.
Its importance is portrayed in the sheer aspects of the application budgeting has in ranging from countries, blocs, mega-empires to an individual’s needs. Budgeting is the process through which plans are created of spending money.
But that is not only and all that budgeting encapsulates. Budgeting is managing both income and expenses. Making a budget is an anticipatory process to determine the spread of finance over a period of time.
The budget then is referred to keep a check and balance over monetary decision making. In conclusion, a budget is a tool that is used to manage and control the resources in order to achieve the goals.
There are two different categories of budgeting, ie:
- Participatory Budgeting
- Traditional Budgeting
The main difference between the two is in where the figures to draw the budgets come from.
1) Traditional Budgeting
Traditional Budgeting refers to the budgets made in the traditional manner from the past. Traditional budgets use prior years budget as the baseline for the current or subsequent budget.
Typically, the executives set out the targeted goals, expectations, and the running capital for the operations of the period of which the budget is made.
Traditional budgets are therefore very quick and easy to make, as most of the data is available from the previous year, the manager in charge of making the budget simply has to add in the incremental amounts and budgeted targets to the base figures.
This is a technique that is used most commonly by governments to prepare national budgets. Many organizations too, use traditional budgeting as it is quick, easy, and simple.
Traditional budgets also provide a solid ground for creating a budget. Since the data, cost centres and all the minute details are already present from prior years budget. As stated above, managers simply need to add incremental costs and targets.
Traditional budget is best suited in situations where the nature, extent and scope of the budget and the activities of the organization are clearly laid out.
A stable organization, for instance, would benefit from a traditional budget because its targets and objectives have been set, managers know what they have to achieve, and therefore allocating budgeted costs becomes easy as there is very little or no uncertainty.
As compared to a startup or an organization that is going to acquire another organization. These are situations of uncertainty and whenever there is uncertainty, preparing a budget becomes difficult because managers in charge of preparing budgets cannot properly identify the scope and objectives that the budget is supposed to achieve.
Risk of inefficiency: On the downside however, with traditional budgets the risk of errors, inefficiency and wastage is quite high. If an error was present in previous budgets, it will carry forth and distort the budget.
Similarly, if the practice in an organization is to simply update the budget each year with incremental figures, then this creates a very high risk of inefficiency and wastage.
Need for review: Budgets for certain departments and areas or different cost centres may need to be reviewed each year, to assess the level of contribution those departments or cost centres are making.
If the contribution level of a department or cost centre has dropped, then it does not make sense to allocate a high level of funds to that department.
Traditional budgets skip over this step, which means that there is a high risk of inefficient allocation of resources, resulting in overall inefficiency and loss of competitive edge for the organization.
2) Participatory Budgeting
Participatory or ‘bottoms up’ budgeting on the other hand involves all the management levels in the process of allocating the budget. As the name suggests, the full chain of command is involved. This budgeting system is now much more widely adopted, especially in district and county levels on public discourses.
Given that it is the middle and lower management-level employees who better know the ground realities of achievable and realistic data sets, they have an active role in designing the objectives, goals and estimating the expense needs. This is a more collaborative approach toward setting future expectations.
Another benefit to the management being involved in setting the budget, apart from more accurate information, is the motivational levels of the said employees. This is a positive psychological impact of participatory budgeting.
However, whereas the participatory budgeting counteracts the negatives presented by the traditional budgeting style, it is not without its own pitfalls.
Time Consuming: Comparatively, participatory budgeting is time consuming. Given the nature of adding the junior levels to contribute in budgetary preparation, there is a lot of to and fro with the executives. This in turn eats time.
Lagging Experience: The involvement of the junior management function also leads to another problem. Not all of them have any experience or skills in dealing with these executive jobs or have the foresight to be able to calculate the targets, production levels, raw materials required etc. or not pushing goals.
Budget Slacking: This brings a major problem of participatory budgeting. If the process of preparing a participatory budget is not overseen by competitive management with relevant internal controls in place, the participatory budget may end up with a high level of budgetary slack incorporated into it.
Managers at every level would want to keep the budgetary targets to an easily attainable limit if their pay and bonuses are pegged to the attainment of certain performance targets.
Which is Better?
Both traditional and participatory budgets serve their own purposes and therefore it would not be right to say which one is better. Traditional budgets are most effective in situations where there is a certainty, the scope, and objectives of the budget and the organization are clear.
Most large organizations use traditional budgeting because it suits their organizational style and needs.
Participatory budgets on the other hand are more effective in organizations with a high level of decentralized working. They are more disruptive in approach, time consuming and also require some specific internal controls to prevent budgetary slack from skewing the budget.
Participatory budgets take a more “involved” approach, thereby affecting employee motivation and also creating a flow of information from the bottom to the top, thus making the upper management aware of issues that they may otherwise not have been aware of.
Therefore, it can be conclusively said that both traditional and participatory budgets have their uses and their pros and cons. It depends upon the management to determine which budgetary approach best suits the organization at any given point in time.