An Analysis of Budgeting Disadvantages in Performance Evaluation

This report analyzes the disadvantages of using budgeting for management performance evaluation. It highlights concerns such as the over-reliance on financial targets, which can neglect non-financial measures like customer satisfaction and employee growth, potentially harming business sustainability. The report also discusses how budgeting can lead to intentional target manipulation and weakened internal controls. To address these issues, the report suggests transitioning to a balanced scorecard approach, which incorporates both financial and non-financial metrics. Additionally, it recommends that budgetary targets be approved by an independent remuneration committee and that performance incentives be linked to both departmental and overall company performance to foster a holistic approach. The report concludes that while budgeting has its place, its limitations must be acknowledged and mitigated to ensure effective and sustainable performance evaluation.

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Budgeting is a critical function for any organisation considering the myriad roles that it plays
for an organisation and the internal stakeholders. One of the key functions of budget is to
evaluate the performance of the management by comparing the actual performance with the
budgeted performance. Typically, the performance linked initiatives of the management may
also be linked to the fulfilment of key budgetary parameters. Despite the frequent use of
budgeting, there are certain key disadvantages with regards its use in performance evaluation.
One of the key concerns is that budgeting tends to focus only on financial targets and does
not include non-financial performance measures. As a result, provide budget linked
performance incentives to management in the long run may result in business sustainability
and related practices being adversely impacted as the management is more likely to be driven
by financial performance (Neely and Adams, 2001). The underlying satisfaction of
employees and customers are two critical parameters that the management needs to pay
attention to which are ignored. Another concern is that this may result in inefficiency in the
budgeting exercise where the targets may be intentionally be fixed so that the same may be
easily achieved and there is maximisation of performance linked incentives. Clearly, this is in
contradiction with thee accepted objective of wealth maximisation for the shareholders over
the long term (Kaplan and Nortan, 2001). Yet another concern with use of budgeting is that
it makes the financial performance vulnerable to window dressing through weakening of
internal controls. This would not only impact internal reporting but would also leave adverse
impact on the external reporting thereby adversely impacting the corporate governance
framework of the firm (Neely, 2005). Lastly, use of budgeting for performance at the
departmental level could lead to issues as each department head would view his/her
department in isolation and aim to achieve the pre-determined targets. As a result, the
performance of the other departments may be adversely impact and hence the company may
report inferior performance. This is clearly not healthy for the firm and the various
stakeholders and need to be prevented (Pritchard et. al.,2008).
From the above discussion, it is apparent that there are certain concerns or disadvantages
which need to be addressed in order to enhance the utility of budgeting based performance
evaluation of management. One of these remedies could be through migration to a balanced
scorecard based approach considering the fact that it does not only focus on the financial
measures but also consider the non-financial measures of performance particularly related to
customer satisfaction and employee growth. As a result, using balanced scorecard instead of
financial measures would result in pre-determined targets from not only financial perspective

but other perspectives such as customer, internal processes and employee. This would ensure
that the business activities are sustainable in nature and financial measures are not boosted by
compromising on the other performance standards. Also, this would reduce the incidence of
window dressing in the financial measures as the non-financial measures are also pivotal for
performance evaluation of the management (Kaplan and Norton, 2001).
A central concern highlighted in the above discussion is that in case of budgeting there is a
risk of targets being fixed intentionally lower. In order to ensure that this does not happen, it
would be imperative that these financial and non-financial targets at the beginning of the year
would be approved by a remuneration committee which would constitute of only non-
executive independent directors so that there is no conflict of interest and the targets
envisaged in the budget are realistic and hence tend to reduce variance on either sides (Neely,
2005). Further, in order to reduce department based conflict with regards to performance
measurement, it would make sense to ensure that 50% of the incentives should be linked to
the achievement of the department related financial and non-financial targets while the
remaining 50% of the targets ought to be linked to the performance of the company as a
whole. This would ensure that the department heads do not think in isolation but are
committed towards organisational growth (Barsky and Bremser, 1999).
Based on the above, it can be concluded that there are certain concerns or disadvantages with
regards to use of budgeting for management performance evaluation. These particularly relate
to over reliance on financial measures and thereby ignoring sustainability besides making the
internal controls vulnerable to being weakened. One of the remedies is to introduce balanced
scorecard measure which would combine both financial and non-financial measures.
Additionally, the budgetary performance targets need to be vetted by a remuneration
committee comprising of non-executive independent directors. Also, firm performance
besides departmental performance must be used as a basis for providing performance based
incentives.

References
Barsky, N. and Bremser, W. (1999) Performance measurement, budgeting and strategic
implementation in the multinational enterprise, Managerial Finance, 25(2), pp.3-15,
Kaplan R. and Norton D. (2001) , The balanced scorecard-measures that drive performance,
Harvard Business Review, 70(1), pp. 71-79,
Neely, A. (2005) The evolution of performance measurement research. Development in the
last decade and a research agenda for the next. International Journal of Operations &
Production Management. 25(12), pp. 1264-1277
Neely, A. and Adams C. (2001) The performance prism perspective. Journal of Cost
Management. 15(1), pp. 7-15.
Pritchard, R. D, Harrell M.M, DiazGranados D and Guzman M.J (2008) The productivity
measurement and enhancement system: A meta-analysis. Journal of Applied Psychology.
93(3), pp. 540-567