After reading this article you will learn about the benefits and limitations of budgeting.
Benefits of Budgeting:
Budgeting assists managers at all levels in carrying out planned activities.
It has the following benefits:
(a) Standards of performance:
Budgets provide standards of performance for various periods and sub-periods, Actual performance can be compared against standards at frequent time intervals and timely correction of deviations can be made.
(b) Budgets facilitate planning:
Budgets specify the time and amount to be spent by various departmental heads and, therefore, serve as the basis for making accurate and definite plans. Budgets are based on defined activities worthy of appraisal and change (flexible). Thus, goals are achieved within the defined targets thereby optimising the use of resources.
It also promotes delegation as budgets limit the activities to be done by the higher and lower level managers. Higher level managers can concentrate on strategic thinking by delegating routine activities to lower levels.
(c) Basis for coordination:
When managers at different levels are involved in making budgets, it coordinates various organisational activities. Managers of different departments at different levels cooperate and coordinate their activities to optimally utilize organisational resources.
Budgetary control coordinates activities of various sub-units to bring them close to overall goals. For instance, sales budget has to be coordinated with purchase budget which further has to coordinate with labour budget. This requires free flow of information amongst various departments which helps to achieve coordination.
(d) Motivation and job satisfaction:
Operating managers participate in preparing the budgets. This increases their motivation, job satisfaction and efficiency of work.
(e) Helps in predicting future:
Budgets help in projecting the impact of future on operations of the firm. Environmental changes can, therefore, be incorporated in the organisational policies and procedures.
(f) Facilitates communication:
Budgets facilitate both horizontal and vertical communication in the organisation. Plans and objectives are communicated down the hierarchy and across the levels to various departments to assess the impact of interdepartmental activities on organisational performance.
(g) Facilitates delegation of authority:
Budgets specify the funds to be spent by whom, when and where and the budgeted areas that may generate additional funds. Financial predictions help top managers to delegate authority to subordinates to carry out the budgeted activities within the limits projected in the budget.
(h) Optimum use of scarce resource:
Finance is a scarce resource. Budgets help in its optimum utilisation in areas which will maximise the profits.
(i) Facilitates control:
Budgets measure the performance of individuals and departments against standards and provide a means for checking deviations in the actual performance. Managers can take actions to overcome the deviations and find out reasons for deviations to avoid their occurrence in future. This provides direction to organisational activities in controlled conditions.
(J) Financial planning:
Budgets help in planning financial activities by estimating the requirement of funds, sources from where funds will be raised and laying the plans, objectives and policies. This optimizes the use of funds and contributes to profitability of the firm.
Limitations of Budgeting:
Budgets suffer from the following limitations:
(a) Overspending:
Sometimes budgets become an end. People believe that if they do not spend the budgeted amount in the given time span, their future allocations will be reduced. This may result in spending in areas where it is not even required.
Sometimes, budgeted amounts remain un-utilized and are, thus, spent during the end of the budgeted time periods to maintain future allocations. This results in over spending and negatively affects organisational efficiency and objectives.
(b) Inflexibility:
Budgets specify the amount to be spent on various items. If managers do not have the discretion to change the amount allocated for different items depending on the situation, there will be overspending in some areas and under-spending in others. Depriving managers of their freedom to spend may divert their attention from organisational goals to the budgeted items. This can be counter-productive for the firms resulting into losses rather than profits.
(c) Projections of future:
Since budgets are based on future predictions, if the events do not occur as projected, budgetary allocations will have to be reallocated. Thus, uncertainties in future can affect the reliability of budgets. However, this does not underestimate the importance of budgets. Scientific forecasting can help in making predictions which are by and large accurate and reliable and, thus, increase the efficiency of budgets.
(d) Hindrance to innovation and change:
When funds are allocated to different operating budgets, procuring additional funds and resources to take advantage of environmental opportunity may not be possible and budgets, thus, may affect the possibility of innovation and change.
(e) Over emphasis on budgeted goals:
To remain within the limits of budgeted goals, managers may ignore overall goals of the organisation and achieve the budgeted goals at the cost of organisational goals.
(f) Based on past results:
Though budgets highlight future projections, past provides important foundation to prepare the budgets. Events which were not important in the past may not, thus, form part of future budgets if they happen to become important in future. This problem can also be overcome by making zero-base budgets where important activities are reviewed for every budgeted period which become part of the budgets.
These limitations can be overcome by giving more time and thought to preparing budgets, inviting positive and constructive suggestions from subordinates, not relying too heavily on past estimates, seeking help of analysts in predicting future and setting standards capable of being achieved.