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Education

Budget Development and Use in Small and Medium-Sized Enterprises

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Howard Armitage examines how small- and medium-sized firms generate operating budgets and use them for control, evaluation, and reward functions.

Image courtesy of interviewee. February 5, 2024

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This video video discusses a research study on the development and use of operating budgets in small and medium enterprises (SMEs). While operating budgets are widely recognized as critical management controls across organizations, most existing research has focused on larger companies. This video video study aimed to fill that gap by examining how SMEs utilize budgets for control, evaluation, and reward purposes.

The researchers conducted in-depth interviews with executives from 12 SMEs to explore four main questions: (1) how budgets are developed (top-down or collaborative), (2) how tightly budgets are used for controlling results, (3) how they are employed for performance evaluation, and (4) how they link to reward systems or compensation.

Key findings include:
1. Most SMEs employ a collaborative approach to budget development rather than a strictly top-down method, particularly in larger SMEs that need decentralized decision-making.
2. While some SMEs use budgets tightly for control purposes, many adopt a looser approach, focusing more on the planning discipline budgets provide rather than strict control.
3. The tight use of budgets for performance evaluation is not widespread; many SMEs feel that the unpredictability of their environments makes it inappropriate to heavily link budgets to evaluations.
4. Linking budgets to compensation occurs in only a few cases, typically limited to sales staff due to similar concerns about environmental uncertainties.

Overall, the research revealed that budgets in SMEs are perceived more as flexible planning tools rather than rigid control mechanisms. The findings suggest a need for management accounting education to incorporate the distinct budgeting dynamics of SMEs, which differ significantly from the processes seen in larger organizations. The research underscores the importance of collaborative budgeting and the role of informal communication in financial management within SMEs.

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We examine the process

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by which operating budgets are developed

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and how they are used specifically, for control,

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evaluation, and reward purposes in small

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and medium sized enterprises.

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Uh, and we do that because small medium enterprises simply

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represent the dominant form of organizations,

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not just in North America, but literally around the world.

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And we found that surprisingly little research has been,

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examined on just how those particular companies use

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what we call management controls.

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Now, we focus on one specific management control,

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which is to your question,

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and that is operating budgets, likely

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because prior research indicates

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that budgets have been a very important,

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control tool in virtually all companies.

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But that research, while extensive,

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has almost always been focused on larger organizations.

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Uh, so what we've done here is conducted, in-depth,

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field studies, which, which really means interviews with,

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with corporations, 12,

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participating small medium enterprises, to address

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really four theory based questions to try to add

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to our knowledge and insight, as to the use

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and development of budgets in small, medium enterprises.

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Um, our first question, of these research questions is,

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is, is fairly straightforward.

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It's just how are budgets developed?

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Are they primarily top down,

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more directed from top management,

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or are they more collaborative and bottom up.

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And then the second, third,

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and fourth research questions examine respectively,

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whether budgets are tightly and,

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and I'll define tightly in a moment here or,

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or loosely, used for controlling results.

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And then for performance evaluation.

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And then finally, for reward purposes

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or compensation, how are they used in SMEs?

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Uh, so this is a first step, I believe,

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to providing a deeper understanding of budget development,

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and use in small medium enterprises.

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And I will talk a little bit towards the end of this,

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about the implications that what our findings have been

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for practice, for future theory development,

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and for management accounting education.

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First, I'll just say that almost anyone who listens to this

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or is part of organizations, they're aware

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that operating budgets are very,

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very common throughout organizations.

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Almost everyone uses them at some point,

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and you can see why, because they,

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help coordinate planning,

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they improve resource allocation.

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They, are useful for a control, idea

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of aligning employees' behavior with organizational goals.

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Uh, so given the pervasive use of how we see budgets used,

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management researchers have long been interested in just

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how are they developed

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and how are they part of the control system.

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So what we're trying to do here is, contribute

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to this literature and practice,

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but to see how they are used for control

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and evaluation purposes in small

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and medium enterprises, an area which seems not

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to have been, the target of most of the,

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budgeting research.

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So, couple of questions then.

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Why focus on operating budgets? Um, two reasons.

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Uh, one, because they're a particularly important element

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of, SMEs control systems.

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Uh, and they're one of the few management controls we see

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that are used extensively, even by smaller companies.

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However, there are fundamental differences

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between the operations of SMEs and larger organizations.

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And we believe, and we were told

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by many in the small medium enterprise market

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that management controls are used differently,

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but we just really don't know how yet.

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And that was part of what we wanted to do.

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So, for example, some have suggested that smaller emphasis,

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sorry, smaller organizations,

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place a higher emphasis on

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more entrepreneurial management styles.

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And if that's the case, formal

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and tight uses of management controls

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may constrain rather than facilitate decision making.

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And SMEs or smaller firms,

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because they have a much higher degree of uncertainty,

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in their day-to-day operations, they're probably going

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to have a looser fit

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for their budget control system than larger organizations.

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But again, this is still largely, speculation.

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And so our study is designed to, address

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that specific issue.

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The, the second reason for operating budgets is, and, and,

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and the SMEs is that SMEs, they're just a dominant,

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segment of all economies.

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Uh, if I just gave you the Canadian examples,

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over 99% of all organizations,

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are classified as small medium enterprises.

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And by, by SME, I mean, between say 105 hundred

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employees, sorry, less than 500 employees for sure.

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Uh, they in total here in Canada contribute over 50%

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of our gross domestic product.

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Uh, SMEs employ almost 90%

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of individuals in the private sector market.

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So absolutely, we just need a better understanding

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of the development and use of budgets in

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SMEs if we are going to contribute

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to practical knowledge within organizations

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and build a little better theory.

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So, to guide the inquiry, then to get into the research,

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we developed four theory based research questions,

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examining specific elements of SMEs.

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And for those researchers in the group, we,

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we focused on these aspects of budget development and use.

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We, we theory and practice from previous research indicates

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that the unique nature of small medium enterprise operations

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may yield some different and important insights.

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So our first research question examines the approach used

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for budget developments in SMEs.

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Specifically, we focus on our questions on whether it's top

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down or a more collaborative approach being employed by

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SMEs and why.

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Our, our next three research questions examine the tightness

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with which budgets are used for control,

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performance evaluation, and for compensation purposes.

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Uh, we focus on these three specific purposes

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because each is well established in the budget literature,

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although it's almost always, again, from

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that large organization perspective.

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I mentioned this word tightness.

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Uh, tightness simply refers to the emphasis that,

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is placed on a specific element of a control system, so

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that organizations can align individual behavior

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with their objectives.

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Um, so tightness, in control purposes,

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for example, would include regular

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and frequent, reviews of actual versus budget,

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results, establishing, accountability

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for significant variances,

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and simply a more formalized approach for explaining

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why results are not according to

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what we thought they would be.

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Um, type budgets for

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evaluation purposes would involve actual versus budget

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results that have a strong influence on employees

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performance evaluations.

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Similarly, type budgets

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for reward purposes would result in budget results,

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having a direct impact on the determination of the salary

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and compensation of individuals.

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So for each of these research questions, we develop,

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and I won't go into this,

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but theory-based reasons why we might observe tight

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or loose use of budgets.

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And again, back to the point that we have had

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so little research on this, we really don't know

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what we're going to come up with.

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It is sort of an inquiry into this whole area,

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and it could go one way or the other.

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We didn't know. Um,

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I'll just mention a little bit on the methodology.

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Um, we, did in-depth interviews with,

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senior executives of 12 small medium enterprises,

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to gain, an insightful knowledge of,

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of the budgeting processes used by their firms.

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Um, the interviews are, are really a good way

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of doing this form of research, much better than,

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surveys or, other,

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other ways in which you don't get face-to-face

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with executives.

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Uh, here it's a particularly rich form of research where,

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not only are we able to ask the questions we want,

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but we're able to get a lot

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of additional information from people

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that we might not even have thought about, prior

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to the actual interview.

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So for those interested, what, what we ended up with was

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following kind of, of mix with our, our 12.

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Uh, we, looked at size,

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and we ranged from the number

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of employees in the organization

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that went from 18 individuals up to 280.

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Um, we looked at different industries, for example, software

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as a service versus manufacturing.

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Uh, we looked at how old these organizations are,

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younger versus older.

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We went from two years in operation up

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to 47 years of operation.

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Uh, the revenues also had quite a range from less than

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1 million up to 60 million.

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And the other important part here is that given our

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research questions on budgets, informants had to be really

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knowledgeable about how budgets are developed

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and used, in their organization.

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So we conducted every one of those interviews with the CEOs

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or the CFOs.

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And in general, we, our interviews lasted,

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in a semi-structured way from anywhere from 45

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to about 90 minutes.

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So that gives you a bit of, of our, our methodology.

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We know what we are interested in. The research questions.

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I, I'll, I'll repeat them again to make sure we're,

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we're on the same wavelength.

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But here, here's the, the key findings

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that we were able to come up with.

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So for research question number one, which is

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how do organizations use budget top down or more bottom up?

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Uh, most of the SMEs in the sample tended

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to follow a collaborative, rather than a top down approach

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to developing budgets.

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And they did involve managers throughout the organization.

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Now, this was particularly true in the case of the larger

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or the medium size SME companies,

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which is quite understandable, I think

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because the larger SMEs are, the more likely they are

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to have responsibility centers, more likely the needs

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for decentralized decision making.

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Uh, and what we also found in this collaborative part is

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many of the SMEs were involving their boards

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in finalizing the budget, indicating to us

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that they often ask the board to,

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provide input into the development process.

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Now, that same collaboration we saw with smaller SMEs,

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but there were two at the very low end of the size,

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which used a much more top down and autocratic approach.

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Probably not surprising, again,

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because from those company's point of view, it was clear

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to their management that they're small enough.

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They knew damn near everything that there was

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to be known about that organization's development.

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And, they just felt that, finalizing the budgets

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with other people in the organization was

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simply unnecessary.

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But the findings there largely are that there was a,

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a collaborative, and I'll, I'll just give a, a,

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a a little moments, more on this later

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as I wrap this up,

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because we found a couple

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of other interesting things in this collaboration.

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Um, research question two was, how do we use budgets

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for control?

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Um, and do we use a tight use of budgets for control

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or more loose?

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Um, more than half,

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or I could say, I guess I could say fewer than half of our

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SMEs could be characterized as employing a tight use

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of budget for control purposes.

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Um, and again, our evidence suggests that in part,

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the looser use of budgets for control

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that we observe just may be a function of the challenges

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of creating accurate budgets when you're growing so quickly

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and your, environment is so uncertain.

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Um, most of the evidence that we found suggests

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that the key value for budgets in smaller companies

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seems to be derived from the discipline

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that it creates in planning activities rather than its use

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as a control tool.

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Quite a different finding from

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what we would find in the larger organizations.

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Um, our third, research question again, has to do

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with the tightness for evaluation purposes, budgets

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and evaluation,

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and kind of consistent with the theory-based reasoning

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that we use to develop research.

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Question, two, most of the SMEs,

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characterizes employing tight use of budgets for control,

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also utilized tight uses of budgets for their evaluation.

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However, there weren't many of, of the 12, two small,

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two medium sized companies.

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Four in total tended to link results to,

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performance evaluation, outcomes.

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Uh, the others, were not quite so ready to do that.

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Um, mainly because their companies they felt were,

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either too young,

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budget accuracy was perhaps a, a concern.

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And if I could just quote from one of the CEOs that

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was asked, why don't you do this?

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Uh, basically said, there are just

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so many variables that are happening.

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So many things are up in the air

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that right now we don't think it would be a proper use

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of budgets to tie it tightly to performance evaluation.

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And we got a few of these kinds

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of comments back from, from CEOs.

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So that brings us to the fourth

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and final research question, which is, a question

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of whether or not budgets are tightly tied to,

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compensation.

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Um, three of our SMEs in the sample did employ,

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and it's the same group that were part

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of the performance evaluation, for purpose

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of determining rewards,

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but clearly it was only for one group of individuals,

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and that was the sales staff.

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Those companies tended to employ tight budgets

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for performance evaluation purposes as well.

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Uh, so a, a again, this idea of linking budget results

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to compensation, used only in a minority of cases,

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and probably because of this uncertainty that the budget is

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in, in a, in a very rapidly changing environment,

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these firms are facing with, it would be a mistake

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to try to put too much emphasis on the compensation

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side of reaching a budget.

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So overall, what, what have we got?

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Um, the use of budgets to motivate employees by linking them

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to, performance evaluations

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and rewards is somewhat limited.

16:14.275 --> 16:17.965
However, what we do tend to see is that there's a lot

16:17.965 --> 16:19.805
of collaboration that is going on.

16:20.105 --> 16:22.405
Boards are, being involved,

16:22.865 --> 16:25.045
and, for the most part,

16:25.195 --> 16:28.925
control is being carried out in, in different manners, more

16:28.925 --> 16:31.725
for planning than it is for actual control purposes.

16:32.345 --> 16:36.325
We did a, a workshop, by inviting not only the people

16:36.385 --> 16:39.805
who were part of the research group, that we met

16:39.805 --> 16:41.085
with all the CEOs,

16:41.345 --> 16:44.045
but the, the general public as well in our area

16:44.665 --> 16:46.645
to just disseminate these results.

16:47.185 --> 16:50.565
Uh, and what we did, find

16:50.665 --> 16:52.285
and be able to talk about,

16:52.505 --> 16:53.965
and that these individuals seem

16:53.965 --> 16:57.925
to be quite interested in is, one, the results are quite

16:58.445 --> 17:01.845
relevant to systems designers in these SMEs.

17:01.845 --> 17:04.925
Those systems designers could be exactly by that name,

17:04.985 --> 17:06.005
or the CEOs

17:06.005 --> 17:09.565
and the CFOs, in showing, again, the benefits

17:09.565 --> 17:11.965
of budgeting, and no one was arguing of that,

17:12.385 --> 17:14.885
but really more so as a critical element

17:15.145 --> 17:18.925
of the planning process rather than as a fixed

17:19.145 --> 17:23.125
and static tool for tightly, controlling

17:23.345 --> 17:25.325
and trying to monitoring behavior.

17:25.785 --> 17:28.925
Uh, this is very distinct from larger company settings

17:29.095 --> 17:31.685
where budgets are claimed to be beneficial, not just

17:31.685 --> 17:35.085
for planning, but certainly for these control purposes

17:35.085 --> 17:36.125
that we described here.

17:37.545 --> 17:40.365
Uh, moreover, I think our findings suggest that,

17:40.645 --> 17:43.005
SME top management,

17:43.525 --> 17:46.685
perceives value in employing collaborative approaches

17:46.705 --> 17:51.005
to budget development, both in terms of engaging,

17:51.845 --> 17:55.205
employees more, and certainly in developing better informed

17:55.205 --> 17:56.365
budget estimates.

17:56.625 --> 17:58.685
So that, that's one, good takeaway.

17:59.265 --> 18:02.165
Uh, for the academics that came to the group

18:02.185 --> 18:05.365
and are interested in the article, there's consequences

18:05.505 --> 18:09.245
for the development of theory, about the use of budgets,

18:09.545 --> 18:12.285
by SME for control purposes.

18:12.895 --> 18:16.925
We've documented a relatively loose use of budgets

18:17.225 --> 18:19.965
as a formal control tool in our sample SMEs,

18:20.705 --> 18:22.325
but some of our informants sort

18:22.325 --> 18:23.845
of took us in a different direction

18:24.065 --> 18:28.445
and said that, the informal, channels

18:28.445 --> 18:32.685
of communication and performance relative to budgets

18:33.755 --> 18:36.885
also serve as one of their important control mechanisms.

18:37.025 --> 18:40.005
And, and what that's doing, I think, is telling us that,

18:40.275 --> 18:45.045
control tightness in an SME may be more nuanced,

18:45.515 --> 18:46.925
than in larger companies

18:46.925 --> 18:50.605
where they're using more budget review meetings, more,

18:50.985 --> 18:53.085
variance analysis types of things.

18:53.785 --> 18:56.365
And finally, one of the things that I mentioned earlier

18:56.365 --> 18:58.525
that I wanted to come back to is,

18:58.745 --> 19:01.005
we had not seen examples

19:01.005 --> 19:02.885
before with large organizations

19:03.655 --> 19:06.205
where they would revise their budgets

19:06.255 --> 19:07.925
after they've been finalized.

19:08.425 --> 19:10.565
In most large organizations,

19:10.575 --> 19:13.085
there is a budget that is fixed.

19:13.645 --> 19:16.605
Forecasts certainly are made to change the nature of

19:16.605 --> 19:19.205
what the future will be, but in many of our SMEs,

19:19.225 --> 19:23.125
we were finding they were actually revising those budgets

19:23.335 --> 19:24.725
after they've been finalized.

19:25.145 --> 19:27.005
And this is sort of interesting

19:27.005 --> 19:28.725
because it's a response

19:28.745 --> 19:31.325
to unforeseen changes in the environment

19:31.745 --> 19:35.365
and maybe a manifestation manifestation for their need

19:35.385 --> 19:36.525
for agility.

19:37.185 --> 19:40.405
So, as such, I think our evidence suggests that management,

19:40.785 --> 19:44.565
at SME companies may be less likely

19:44.665 --> 19:47.405
to view budgets as a static benchmark,

19:48.065 --> 19:52.125
but instead considered to be more flexible in nature

19:52.865 --> 19:55.805
and budget estimates revised as needed

19:55.805 --> 20:00.285
to accommodate changes in the operating environment.

20:00.285 --> 20:04.645
So the final, contribution to this, I think not only,

20:06.165 --> 20:09.305
is, is to assist individuals in firms

20:09.405 --> 20:12.985
to understand this, but I think primarily as an educator,

20:13.365 --> 20:15.145
there's huge implications here

20:15.285 --> 20:16.865
for management accounting, education.

20:17.405 --> 20:20.145
Uh, mostly when we teach,

20:20.675 --> 20:23.865
we're basing it on these maybe mythical

20:24.165 --> 20:27.305
and very large manufacturing organizations.

20:27.885 --> 20:32.185
Um, and all our teaching sort of makes these assumptions of,

20:32.445 --> 20:34.145
large practice.

20:34.565 --> 20:36.745
But SMEs are the dominant form

20:37.205 --> 20:39.825
of organizations literally around the world.

20:40.365 --> 20:42.745
And we believe our findings will be,

20:42.745 --> 20:47.185
and I know have already been useful to post-secondary

20:47.955 --> 20:49.195
educators, as well

20:49.195 --> 20:51.435
as professional accounting bodies like the,

20:51.435 --> 20:52.475
chartered accountancy

20:52.495 --> 20:56.955
and CPA institutes to sort of revise their own curriculums

20:57.215 --> 21:00.755
and help provide students, upcoming individuals

21:00.755 --> 21:03.995
with insights as to how dis the,

21:03.995 --> 21:08.315
the distinct ways in which budgets can be used in smaller

21:08.345 --> 21:10.555
organizations rather than the future.

21:10.575 --> 21:14.275
Let me just take you back to one precursor to this study

21:14.305 --> 21:15.555
that we had done.

21:16.095 --> 21:17.635
Um, I had an opportunity

21:17.695 --> 21:19.875
of having a sabbatical in Australia,

21:20.615 --> 21:21.675
and, one

21:21.675 --> 21:25.755
of my colleagues there had the same concern I did that to

21:25.755 --> 21:28.035
what extent are the management controls,

21:28.135 --> 21:30.195
and I'll describe what I mean by that in a second.

21:30.615 --> 21:34.075
Uh, are they being used at all by SMEs now?

21:34.075 --> 21:37.315
We found that budgets were the one thing which were very

21:37.315 --> 21:39.195
highly used everywhere we went,

21:39.215 --> 21:42.595
and that that's why we wanted to do this particular study

21:42.745 --> 21:45.595
that I just referred to, to understand better

21:45.975 --> 21:48.435
how they're being used, and to what extent.

21:49.535 --> 21:52.515
But when we talk about management controls, there are

21:52.855 --> 21:56.715
so many other things like the, the specific type of,

21:56.715 --> 21:59.835
of perhaps variance analysis that take place.

22:00.455 --> 22:05.315
Uh, there are the, all these statistics on return on,

22:05.495 --> 22:07.955
assets, the, in other words,

22:08.105 --> 22:12.755
what we did was we listed 13 management controls that are

22:13.375 --> 22:15.995
widely promoted in our textbooks

22:16.415 --> 22:20.835
and that the associations require upcoming accountants

22:20.855 --> 22:22.435
and things to have a good knowledge of.

22:22.935 --> 22:24.955
But what we learned from the SMEs,

22:24.975 --> 22:28.995
and again, these are companies less than 500 people, is

22:28.995 --> 22:30.315
that only one

22:30.335 --> 22:33.635
or two of these management controls were used at all.

22:34.535 --> 22:37.075
In fact, it was a lot of seat of the pants type thing.

22:37.075 --> 22:38.115
As you can imagine,

22:38.675 --> 22:41.875
a very uncertain environment in which they're operating a

22:41.895 --> 22:45.875
lot, of, movement ahead was based on who you know

22:45.935 --> 22:48.115
and how well you can work a network, whether

22:48.115 --> 22:50.435
or not you can find the venture capitalists that you need

22:50.435 --> 22:52.195
to help you support your next thing.

22:52.335 --> 22:54.355
But the specific management controls

22:54.355 --> 22:58.195
that were break even analysis and process costing,

22:58.195 --> 22:59.635
and these kinds of things, which are

23:00.015 --> 23:02.075
so important on the educational side,

23:02.575 --> 23:06.035
are just not being used at all in the SME world.

23:06.455 --> 23:10.435
So that, was kind of an interesting thing.

23:11.105 --> 23:13.995
It's helped us to talk to the professional groups

23:14.575 --> 23:17.835
and say, there's things that aren't happening,

23:17.855 --> 23:19.755
but there's a lot of things that are happening

23:19.865 --> 23:20.875
that you're not covering.

23:21.255 --> 23:23.755
So as an example of that, we have,

23:23.815 --> 23:27.355
and that's one of the reasons we picked, these kinds of,

23:27.575 --> 23:30.195
software as a service firms,

23:30.425 --> 23:34.515
because there's a whole world of companies that are now,

23:34.805 --> 23:37.715
we're working on a subscription basis,

23:38.535 --> 23:41.955
and it's reoccurring revenue as, as the,

23:42.135 --> 23:44.915
the whole men mantra for getting ahead

23:45.635 --> 23:49.685
Very little is mentioned in our educational materials

23:49.705 --> 23:51.645
or in the association materials.

23:51.985 --> 23:54.885
So how does that affect the control systems

23:54.945 --> 23:57.085
of organizations when you're dealing

23:57.085 --> 23:59.165
with a completely different revenue model

23:59.435 --> 24:00.725
than we've assumed in the past?

24:01.065 --> 24:03.165
So that that's all part of what's there

24:03.785 --> 24:05.005
in terms of, of the future.

24:05.565 --> 24:08.765
I, I have to tell you, I'm now happily retired,

24:09.145 --> 24:11.525
so I leave this to my younger colleagues.

00:00 - We examine the process by which operating budgets are developed and how they are used specifically, for control, evaluation, and reward purposes in small and medium sized enterprises. and we do that because small medium enterprises simply

00:19 - represent the dominant form of organizations, not just in North America, but literally around the world. And we found that surprisingly little research has been, examined on just how those particular companies use what we call management controls. Now, we focus on one specific management control, which is to your question, and that is operating budgets, likely because prior research indicates that budgets have been a very important,

00:49 - control tool in virtually all companies. But that research, while extensive, has almost always been focused on larger organizations. so what we've done here is conducted, in-depth, field studies, which, which really means interviews with, with corporations, 12, participating small medium enterprises, to address really four theory based questions to try to add to our knowledge and insight, as to the use and development of budgets in small, medium enterprises.

01:26 - our first question, of these research questions is, is, is fairly straightforward. It's just how are budgets developed? Are they primarily top down, more directed from top management, or are they more collaborative and bottom up. And then the second, third, and fourth research questions examine respectively, whether budgets are tightly and, and I'll define tightly in a moment here or,

01:53 - or loosely, used for controlling results. And then for performance evaluation. And then finally, for reward purposes or compensation, how are they used in SMEs? so this is a first step, I believe, to providing a deeper understanding of budget development, and use in small medium enterprises. And I will talk a little bit towards the end of this, about the implications that what our findings have been for practice, for future theory development,

02:26 - and for management accounting education. First, I'll just say that almost anyone who listens to this or is part of organizations, they're aware that operating budgets are very, very common throughout organizations. Almost everyone uses them at some point, and you can see why, because they, help coordinate planning, they improve resource allocation. They, are useful for a control, idea

02:52 - of aligning employees' behavior with organizational goals. so given the pervasive use of how we see budgets used, management researchers have long been interested in just how are they developed and how are they part of the control system. So what we're trying to do here is, contribute to this literature and practice, but to see how they are used for control and evaluation purposes in small and medium enterprises, an area which seems not

03:25 - to have been, the target of most of the, budgeting research. So, couple of questions then. Why focus on operating budgets? two reasons. one, because they're a particularly important element of, SMEs control systems. and they're one of the few management controls we see that are used extensively, even by smaller companies. However, there are fundamental differences between the operations of SMEs and larger organizations.

03:56 - And we believe, and we were told by many in the small medium enterprise market that management controls are used differently, but we just really don't know how yet. And that was part of what we wanted to do. So, for example, some have suggested that smaller emphasis, sorry, smaller organizations, place a higher emphasis on more entrepreneurial management styles. And if that's the case, formal

04:23 - and tight uses of management controls may constrain rather than facilitate decision making. And SMEs or smaller firms, because they have a much higher degree of uncertainty, in their day-to-day operations, they're probably going to have a looser fit for their budget control system than larger organizations. But again, this is still largely, speculation. And so our study is designed to, address that specific issue.

04:52 - The, the second reason for operating budgets is, and, and, and the SMEs is that SMEs, they're just a dominant, segment of all economies. if I just gave you the Canadian examples, over 99% of all organizations, are classified as small medium enterprises. And by, by SME, I mean, between say 105 hundred employees, sorry, less than 500 employees for sure. they in total here in Canada contribute over 50% of our gross domestic product.

05:29 - SMEs employ almost 90% of individuals in the private sector market. So absolutely, we just need a better understanding of the development and use of budgets in SMEs if we are going to contribute to practical knowledge within organizations and build a little better theory. So, to guide the inquiry, then to get into the research, we developed four theory based research questions, examining specific elements of SMEs.

06:05 - And for those researchers in the group, we, we focused on these aspects of budget development and use. We, we theory and practice from previous research indicates that the unique nature of small medium enterprise operations may yield some different and important insights. So our first research question examines the approach used for budget developments in SMEs. Specifically, we focus on our questions on whether it's top down or a more collaborative approach being employed by SMEs and why.

06:42 - Our, our next three research questions examine the tightness with which budgets are used for control, performance evaluation, and for compensation purposes. we focus on these three specific purposes because each is well established in the budget literature, although it's almost always, again, from that large organization perspective. I mentioned this word tightness. tightness simply refers to the emphasis that, is placed on a specific element of a control system, so

07:18 - that organizations can align individual behavior with their objectives. so tightness, in control purposes, for example, would include regular and frequent, reviews of actual versus budget, results, establishing, accountability for significant variances, and simply a more formalized approach for explaining why results are not according to what we thought they would be.

07:49 - type budgets for evaluation purposes would involve actual versus budget results that have a strong influence on employees performance evaluations. Similarly, type budgets for reward purposes would result in budget results, having a direct impact on the determination of the salary and compensation of individuals. So for each of these research questions, we develop, and I won't go into this,

08:20 - but theory-based reasons why we might observe tight or loose use of budgets. And again, back to the point that we have had so little research on this, we really don't know what we're going to come up with. It is sort of an inquiry into this whole area, and it could go one way or the other. We didn't know. I'll just mention a little bit on the methodology. we, did in-depth interviews with,

08:47 - senior executives of 12 small medium enterprises, to gain, an insightful knowledge of, of the budgeting processes used by their firms. the interviews are, are really a good way of doing this form of research, much better than, surveys or, other, other ways in which you don't get face-to-face with executives. here it's a particularly rich form of research where, not only are we able to ask the questions we want,

09:19 - but we're able to get a lot of additional information from people that we might not even have thought about, prior to the actual interview. So for those interested, what, what we ended up with was following kind of, of mix with our, our 12. we, looked at size, and we ranged from the number of employees in the organization that went from 18 individuals up to 280.

09:44 - we looked at different industries, for example, software as a service versus manufacturing. we looked at how old these organizations are, younger versus older. We went from two years in operation up to 47 years of operation. the revenues also had quite a range from less than 1 million up to 60 million. And the other important part here is that given our research questions on budgets, informants had to be really

10:18 - knowledgeable about how budgets are developed and used, in their organization. So we conducted every one of those interviews with the CEOs or the CFOs. And in general, we, our interviews lasted, in a semi-structured way from anywhere from 45 to about 90 minutes. So that gives you a bit of, of our, our methodology. We know what we are interested in. The research questions. I, I'll, I'll repeat them again to make sure we're,

10:47 - we're on the same wavelength. But here, here's the, the key findings that we were able to come up with. So for research question number one, which is how do organizations use budget top down or more bottom up? most of the SMEs in the sample tended to follow a collaborative, rather than a top down approach to developing budgets. And they did involve managers throughout the organization. Now, this was particularly true in the case of the larger

11:16 - or the medium size SME companies, which is quite understandable, I think because the larger SMEs are, the more likely they are to have responsibility centers, more likely the needs for decentralized decision making. and what we also found in this collaborative part is many of the SMEs were involving their boards in finalizing the budget, indicating to us that they often ask the board to, provide input into the development process.

11:48 - Now, that same collaboration we saw with smaller SMEs, but there were two at the very low end of the size, which used a much more top down and autocratic approach. Probably not surprising, again, because from those company's point of view, it was clear to their management that they're small enough. They knew damn near everything that there was to be known about that organization's development. And, they just felt that, finalizing the budgets with other people in the organization was

12:20 - simply unnecessary. But the findings there largely are that there was a, a collaborative, and I'll, I'll just give a, a, a a little moments, more on this later as I wrap this up, because we found a couple of other interesting things in this collaboration. research question two was, how do we use budgets for control? and do we use a tight use of budgets for control

12:48 - or more loose? more than half, or I could say, I guess I could say fewer than half of our SMEs could be characterized as employing a tight use of budget for control purposes. and again, our evidence suggests that in part, the looser use of budgets for control that we observe just may be a function of the challenges of creating accurate budgets when you're growing so quickly and your, environment is so uncertain.

13:20 - most of the evidence that we found suggests that the key value for budgets in smaller companies seems to be derived from the discipline that it creates in planning activities rather than its use as a control tool. Quite a different finding from what we would find in the larger organizations. our third, research question again, has to do with the tightness for evaluation purposes, budgets and evaluation,

13:52 - and kind of consistent with the theory-based reasoning that we use to develop research. Question, two, most of the SMEs, characterizes employing tight use of budgets for control, also utilized tight uses of budgets for their evaluation. However, there weren't many of, of the 12, two small, two medium sized companies. Four in total tended to link results to, performance evaluation, outcomes. the others, were not quite so ready to do that.

14:28 - mainly because their companies they felt were, either too young, budget accuracy was perhaps a, a concern. And if I could just quote from one of the CEOs that was asked, why don't you do this? basically said, there are just so many variables that are happening. So many things are up in the air that right now we don't think it would be a proper use of budgets to tie it tightly to performance evaluation.

14:57 - And we got a few of these kinds of comments back from, from CEOs. So that brings us to the fourth and final research question, which is, a question of whether or not budgets are tightly tied to, compensation. three of our SMEs in the sample did employ, and it's the same group that were part of the performance evaluation, for purpose of determining rewards,

15:24 - but clearly it was only for one group of individuals, and that was the sales staff. Those companies tended to employ tight budgets for performance evaluation purposes as well. so a, a again, this idea of linking budget results to compensation, used only in a minority of cases, and probably because of this uncertainty that the budget is in, in a, in a very rapidly changing environment, these firms are facing with, it would be a mistake to try to put too much emphasis on the compensation

16:00 - side of reaching a budget. So overall, what, what have we got? the use of budgets to motivate employees by linking them to, performance evaluations and rewards is somewhat limited. However, what we do tend to see is that there's a lot of collaboration that is going on. Boards are, being involved, and, for the most part, control is being carried out in, in different manners, more

16:28 - for planning than it is for actual control purposes. We did a, a workshop, by inviting not only the people who were part of the research group, that we met with all the CEOs, but the, the general public as well in our area to just disseminate these results. and what we did, find and be able to talk about, and that these individuals seem to be quite interested in is, one, the results are quite

16:58 - relevant to systems designers in these SMEs. Those systems designers could be exactly by that name, or the CEOs and the CFOs, in showing, again, the benefits of budgeting, and no one was arguing of that, but really more so as a critical element of the planning process rather than as a fixed and static tool for tightly, controlling and trying to monitoring behavior. this is very distinct from larger company settings

17:29 - where budgets are claimed to be beneficial, not just for planning, but certainly for these control purposes that we described here. moreover, I think our findings suggest that, SME top management, perceives value in employing collaborative approaches to budget development, both in terms of engaging, employees more, and certainly in developing better informed budget estimates. So that, that's one, good takeaway.

17:59 - for the academics that came to the group and are interested in the article, there's consequences for the development of theory, about the use of budgets, by SME for control purposes. We've documented a relatively loose use of budgets as a formal control tool in our sample SMEs, but some of our informants sort of took us in a different direction and said that, the informal, channels of communication and performance relative to budgets

18:33 - also serve as one of their important control mechanisms. And, and what that's doing, I think, is telling us that, control tightness in an SME may be more nuanced, than in larger companies where they're using more budget review meetings, more, variance analysis types of things. And finally, one of the things that I mentioned earlier that I wanted to come back to is, we had not seen examples before with large organizations

19:03 - where they would revise their budgets after they've been finalized. In most large organizations, there is a budget that is fixed. Forecasts certainly are made to change the nature of what the future will be, but in many of our SMEs, we were finding they were actually revising those budgets after they've been finalized. And this is sort of interesting because it's a response

19:28 - to unforeseen changes in the environment and maybe a manifestation manifestation for their need for agility. So, as such, I think our evidence suggests that management, at SME companies may be less likely to view budgets as a static benchmark, but instead considered to be more flexible in nature and budget estimates revised as needed to accommodate changes in the operating environment. So the final, contribution to this, I think not only,

20:06 - is, is to assist individuals in firms to understand this, but I think primarily as an educator, there's huge implications here for management accounting, education. mostly when we teach, we're basing it on these maybe mythical and very large manufacturing organizations. and all our teaching sort of makes these assumptions of, large practice. But SMEs are the dominant form

20:37 - of organizations literally around the world. And we believe our findings will be, and I know have already been useful to post-secondary educators, as well as professional accounting bodies like the, chartered accountancy and CPA institutes to sort of revise their own curriculums and help provide students, upcoming individuals with insights as to how dis the, the distinct ways in which budgets can be used in smaller

21:08 - organizations rather than the future. Let me just take you back to one precursor to this study that we had done. I had an opportunity of having a sabbatical in Australia, and, one of my colleagues there had the same concern I did that to what extent are the management controls, and I'll describe what I mean by that in a second. are they being used at all by SMEs now?

21:34 - We found that budgets were the one thing which were very highly used everywhere we went, and that that's why we wanted to do this particular study that I just referred to, to understand better how they're being used, and to what extent. But when we talk about management controls, there are so many other things like the, the specific type of, of perhaps variance analysis that take place. there are the, all these statistics on return on, assets, the, in other words,

22:08 - what we did was we listed 13 management controls that are widely promoted in our textbooks and that the associations require upcoming accountants and things to have a good knowledge of. But what we learned from the SMEs, and again, these are companies less than 500 people, is that only one or two of these management controls were used at all. In fact, it was a lot of seat of the pants type thing. As you can imagine,

22:38 - a very uncertain environment in which they're operating a lot, of, movement ahead was based on who you know and how well you can work a network, whether or not you can find the venture capitalists that you need to help you support your next thing. But the specific management controls that were break even analysis and process costing, and these kinds of things, which are so important on the educational side, are just not being used at all in the SME world.

23:06 - So that, was kind of an interesting thing. It's helped us to talk to the professional groups and say, there's things that aren't happening, but there's a lot of things that are happening that you're not covering. So as an example of that, we have, and that's one of the reasons we picked, these kinds of, software as a service firms, because there's a whole world of companies that are now, we're working on a subscription basis,

23:38 - and it's reoccurring revenue as, as the, the whole men mantra for getting ahead Very little is mentioned in our educational materials or in the association materials. So how does that affect the control systems of organizations when you're dealing with a completely different revenue model than we've assumed in the past? So that that's all part of what's there in terms of, of the future.

24:05 - I, I have to tell you, I'm now happily retired, so I leave this to my younger colleagues.

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