Setting the Difficulty Level for a Budget

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Participation in setting targets

Participation in the budgeting process will improve motivation and so will improve the quality of budget decisions and the efforts of individuals to achieve their budget targets.

However, this may be time consuming and may result in a wide range of targets which are seen as unfair.

There are basically two ways in which a budget can be set: from the top down (imposed budget) or from the bottom up (participatory budget).

Top down budget

This is also called an ‘authoritative’ or ‘non-participative’ budget as it is set without allowing the ultimate budget holder the opportunity to participate in the budgeting process.

These budgets will begin with upper level management establishing parameters under which the budget is to be prepared.

Lower-level personnel have very little input in setting the overall goals of the organization as they are essentially reduced to doing the basic budget calculations consistent with directives.

Advantages of a top down budget
  1. Top-down budgets can set a tone for the organization. They signal expected sales and production activity that the organization is supposed to reach.

  2. Budgets will be in line with corporate objectives.

  3. Decisions taken by experienced managers.

  4. Budgetary slack reduced.

Disadvantages of a top down budget
  1. Lower-level managers may view the budget as dictatorial.

  2. 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.

Bottom up budget

The budget holders have the opportunity to participate in setting their own budgets. In fact, the lowest level organisational units are asked to submit their estimates of expenditure for the next year.

Senior management, meanwhile, has made a forecast of the income it expects to receive. There maybe a negative variance between the forecast revenue and the sum of the departments’ budgets.

The variance is resolved by lengthy discussions or arbitrary decisions. This type of budget is also called participative budget.

Advantages of a bottom up budget
  1. Improved employee morale and job satisfaction – hence increased motivation.

  2. The budget is prepared by those who have the best knowledge of their own specific areas of operation – better information.

  3. Increases managers’ understanding and commitment.

  4. Better communication between departments.

Disadvantages of a bottom up budget
  1. Generally more time consuming and expensive to develop and administer.

  2. Some managers may try to "pad" their budget, giving them more room for mistakes and inefficiency - budgetary slack (bias).

  3. Budgets may not be in line with corporate objectives – dysfunctional behaviour.

  4. Decisions made by inexperienced managers.

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