Budget Processes and Human Behavior
A comprehensive budget usually involves all segments of a business. As a result, representatives from each unit are typically included throughout the process. The process is likely to be spearheaded by a budget committee consisting of senior level personnel. Such individuals bring valuable insights about all aspects of sales, production, and other phases of operations. Not only are these individuals ideally positioned to provide the best possible information relative to their respective units, they also need to be present to effectively advocate for the opportunities and resource needs within their unit.
The budget committee's work is not necessarily complete once the budget document is prepared and approved. A remaining responsibility for many committees is to continually monitor progress against the budget, and potentially recommend mid-course corrections. The budget committee's decisions can greatly impact the fate of specific business units, in terms of resources made available as well as setting the benchmarks that will be used to assess performance. As a result, members of the budget committee will generally take their task very seriously.
The budget construction process will normally follow the organizational chart. Each component of the entity will be involved in preparing budget information relative to its unit. This information is successively compiled together as it is passed up through the organization until an overall budget plan is achieved. But, beyond the data compilation, there is a critical difference in how budgets are actually developed among different organizations. Some entities follow a top-down, or mandated approach. Others utilize a bottom-up, or participative philosophy.
Some entities will follow a top-down mandated approach to budgeting. These budgets will begin with upper level management establishing parameters under which the budget is to be prepared. These parameters can be general or specific. They can cover sales goals, expenditure levels, guidelines for compensation, and more. Lower-level personnel have very little input in setting the overall goals of the organization. The upper-level executives call the shots, and lower-level units are essentially reduced to doing the basic budget calculations consistent with directives. Mid-level executives may color the budget process by refining the leadership directives as the budget information is passed down through the organization.
One disadvantage of the top-down approach is that lower-level managers may view the budget as a dictatorial standard. Resentment can be fostered in such an environment. Further, such budgets can sometimes provide ethical challenges, as lower-level managers may find themselves put in a position of ever-reaching to attain unrealistic targets for their units.
On the positive side, top-down budgets can set a tone for the organization. They signal expected sales and production activity that the organization is supposed to reach. Some of the most efficient and successful organizations have a hallmark strategy of being "lean and mean." The budget is a most effective communication device in getting employees to hear the message and perform accordingly.
The bottom-up participative approach is driven by involving lower-level employees in the budget development process. Top management may initiate the budget process with general budget guidelines, but it is the lower-level units that drive the development of budgets for their units. These individual budgets are then grouped and regrouped to form a divisional budget with mid-level executives adding their input along the way. Eventually top management and the budget committee will receive the overall plan. As you might suspect, the budget committee must then review the budget components for consistency and coordination. This may require several iterations of passing the budget back down the ladder for revision by lower units. Ultimately, a final budget is reached.
The participative budget approach is viewed as self-imposed. As a result, it is argued that it improves employee morale and job satisfaction. It fosters the "team-based" management philosophy that has proven to be very effective for modern organizations. Furthermore, the budget is prepared by those who have the best knowledge of their own specific areas of operation. This should allow for a more accurate budget; in any event, it certainly removes one of the primary excuses that is used to explain why a particular budget was not met!
On the negative side of the equation, a bottom-up approach is generally more time consuming and expensive to develop and administer. This occurs because of the iterative process needed for its development and coordination. Another potential shortcoming has to do with the fact that some managers may try to "pad" their budget, giving them more room for mistakes and inefficiency. More will be said about this problem shortly, but it is particularly problematic with a highly participative approach.