Participative budgeting definition
/What is Participative Budgeting?
Participative budgeting is a process under which people impacted by a budget are actively involved in the budget creation process. This approach gives lower-level managers a greater sense of ownership in the resulting budget. A purely participative budget does not take high-level strategic considerations into account, so management needs to provide employees with guidelines regarding the overall direction of the company and how their individual departments fit into it.
When participative budgeting is used throughout an organization, the preliminary budgets work their way up through the corporate hierarchy, being reviewed and possibly modified by mid-level managers along the way. Once assembled into a single master budget, it may become apparent that the submitted budgets will not work together, in which case they are sent back down to the originators for another iteration, usually with guidelines noting what senior management is looking for.
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Advantages of Participative Budgeting
There are several advantages to participative budgeting, which are as follows:
Higher level of achievability. This bottom-up approach to budgeting tends to create budgets that are more achievable than are top-down budgets that are imposed on a company by senior management, with much less employee participation.
Improved morale. Participative budgeting is better for morale, and tends to result in greater efforts by employees to achieve what they predicted in the budget.
Enhanced information flow. There is better information flow from the bottom of the organization to senior management, which gives senior managers a better idea of the problems faced by the organization.
Disadvantages of Participative Budgeting
Despite the advantages just noted for participative budgeting, there are also some concerns with it, which are as follows:
Longer creation time. Because of the larger number of employees involved in participatory budgeting, it tends to take longer to create a budget than is the case with a top-down budget that is created by a much smaller number of people.
Higher cost. Given the broader participation level, the labor cost associated with creating a budget is relatively high.
Conservative outcomes. Since the people originating the budget are also the ones whose performance will be compared to it, there is a tendency for participants to adopt a conservative budget with extra expense padding, so that they are reasonably assured of achieving what they predict in the budget. This tendency is more pronounced when employees are paid bonuses based on their performance against the budget. This budgetary slack problem can be mitigated by imposing a budget review by those members of management who are most likely to know when budgets are being padded, and who are allowed to make adjustments to it as needed. Only by following this approach can stretch goals be integrated into a budget.
How to Set Up Participative Budgeting
There is a specific process flow required that will improve the probability of having a successful participative budgeting program. The key steps in this process are noted below.
Establish guidelines. Management must first set broad budgeting guidelines that align with the company's overall strategic goals. These guidelines include assumptions about market conditions, inflation rates, revenue growth, and expense controls. Providing clear parameters ensures that individual departmental budgets are consistent and realistic. This step creates a common framework that facilitates smoother collaboration across all areas of the organization.
Train participants. Before beginning the participative process, all involved employees should be trained in budgeting principles and the specific procedures they must follow. Training helps participants understand the importance of accurate forecasting and the impact of their budget on the company as a whole. It also ensures consistency in how different departments approach estimating revenues and expenses. Well-informed participants are more likely to contribute meaningful, realistic budget proposals.
Solicit initial budget proposals. Each department is tasked with developing its own initial budget based on the provided guidelines and its anticipated needs and goals. Department managers compile forecasts for revenues, expenses, and capital needs, relying on their operational knowledge. This decentralized approach encourages ownership of the budget and motivates departments to set attainable yet challenging targets. Gathering initial proposals creates the foundation for more detailed budget negotiations.
Review and negotiate departmental budgets. After collecting the initial budgets, senior management reviews them for alignment with overall company objectives and financial constraints. This often involves negotiating adjustments with department heads to address discrepancies, resource limitations, or corporate priorities. The negotiation process ensures that all budgets are realistic, achievable, and collectively support company-wide success. It also reinforces communication and cooperation between different levels of the organization.
Finalize the budget. Once all adjustments are made, the final departmental budgets are consolidated into a comprehensive company-wide budget. Management ensures that the combined budgets result in acceptable financial outcomes, such as targeted profit margins and liquidity levels. This consolidated budget then becomes the financial roadmap for the upcoming period, guiding operational and strategic decisions. Finalization of the budget also marks the start of monitoring and performance evaluation activities.