Behavioural aspects in budgeting

Every organisation has a mission, which explains the reason for its existence, and vision, which describes what the organisation aims to be in the future, which is usually inspirational and aspirational. The goal of the organisation will be to achieve its mission and vision.
To achieve the mission and vision, organisations develop strategic plans which have a combination of short-term and long-term strategies. Short-term strategies are implemented through the annual budgets.

Since budgets are used to implement the strategic plan, they are commonly used as tools for controlling and planning in an organisation. When the budget is achieved, it also means short-term strategies have been successfully met. It is therefore important that when preparing a budget the objective should be to achieve the following: implement the strategic plan, motivate staff to achieve the targets, help in evaluating the performance of the organisation and employees, and optimally allocate resources among others.
There are behavioural issues that arise when crafting budgets. If the process is not handled correctly there are certain negative behavioural issues that can arise during the process thereby destroying the benefits that should accrue from having budgets.

Budgets are useful in motivating staff to perform to meet or exceed targets. However, for a budget to motivate staff, the targets set should be achievable and realistic. When the targets are set too low, employees will not be motivated because the targets are easily attainable and therefore the employee will not stretch themselves to achieve them.
In the same vein, if the targets are perceived as unattainable and unachievable the employees will not be motivated to work harder because they see the budget as too difficult anyway. The budget should therefore be set at an achievable level, the level at which actual performance is expected to be, and therefore employees will perform as expected. When setting targets it’s important that the targets be realistic otherwise they will be de-motivational to employees.

A budget contains targets against which the performance of employees and the organisation is evaluated. The evaluation process would normally involve a comparison of actual performance with the budget. This process is however fraught with challenges. One of the challenges is that the budget may have been inaccurate from the beginning, thus making it unachievable for the employee; or with the changes in the environment the budget may become unachievable, as time period progresses; or one departments’ bad performance can interfere with the other department if one department’s performance is dependent on another.

As a result, the outcome of the evaluation will have an adverse impact on the other department and the employee. Poor performance by the employee can impact on incentives or penalties if the attainment of targets is linked to reward. So it’s critical to ensure that the performance of an employee is not negatively affected by another department’s poor performance. The preparation of the budget should therefore bear these issues in mind to avoid causing a dysfunctional behaviour on staff.

When the performance evaluation is linked to a form of reward or penalty system, there is a possibility for managers to distort information passed to upper level of management by underestimating revenues or over-estimating the costs during the budgeting process. The manager’s behaviour towards the budget will be influenced as a result because his actual performance against the budget will either have a favourable or adverse effect on his job appraisal which impacts on his salary increment, annual bonus or chances of promotion. A number of dysfunctional behaviours creep in and so need to be addressed in as discussed below.

For a manager to be motivated to work towards achieving organisational goals there should be goal congruency between the organisation’s goals and those of the manager. The manager’s actual performance will meet the expected level of performance or even exceed the expectations if there is goal congruency. However, if there is no alignment and consistency of the individual’s goals with the organisations’ goals, a case of goal incongruence exists, then the manager will not be motivated to achieve the goals. This behaviour will impact on the actual performance of the organisation resulting in failure to meet the organisation’s short-term and long-term objectives.

To address this problem it’s important that the managers that will be responsible for the budget participate in preparing the budget. There are two methods of preparing budgets. Budget are either prepared top down or bottom up. Under the top down method, top management prepares the budget without consultation of lower level staff and pass on the budget to them for implementation.
However the bottom up method involves lower level employees in the budgeting process. They are consulted. This gives them a sense of commitment and ownership and therefore, they will be motivated to achieve the targets, which they regard as their own. Lower level managers’ participation in budgeting helps to increase their motivation and reduces resistance to the budget as well as reduce possible conflict within the organisation.

Participatory budgeting allows both top management and its lower level managers and employees to have a better understanding on each other’s roles and areas of concern where the budget is concerned. The top management will be able to know whether the targets set are reasonable and realistic. There is however a challenge that needs to be managed when lower level managers are involved in setting the targets. Sometimes managers introduce budgetary slack by underestimating revenues and overestimating costs and expenses so that when the actual results are compared with the budget they will look favourable. Managers will have past experiences when preparing budget and so they can build in some budget slack in their figures.

This type of behaviour is likely to manifest especially when the actual performance has a direct link to the incentives the manager receives. To guard against budgetary slack it’s important for managers to be rewarded for consistently preparing realistic budgets and then they will avoid building a budgetary slack.

l Stewart Jakarasi is a business and financial strategist and a lecturer in business strategy, advanced performance management and entrepreneurship. For assistance in implementing some of the concepts discussed in these articles please contact him on the following contacts: sjakarasi@gmail.com, call on +266 58881062 or WhatsApp +266 62110062.