Budgeting involves cost and time to prepare. The benefits of budgeting must outweigh the drawbacks. A budget can be advantageous because it:
Links objectives and resources.
Communicates to managers what is expected of them. Any problems in communication and working relationships are identified. Resources and requirements are identified.
Establishes guidelines in the form of a road map to proceed in the right direction. Improves managerial decision making because emphasis is on future events and associated opportunities.
Encourages delegation of responsibility and enables managers to focus more on the specifics of their plans and how realistic the plans are, and how such plans may be effectively achieved.
Provides an accurate analytical technique.
Provides better management of subordinates. For example, a manager can use the budget to encourage salespeople to consider their clientele in long-term strategic terms.
Fosters careful study before making decisions.
Helps management become aware of the problems faced by lower levels within the organization. It promotes labor relations.
Allows for thinking how to make operations and resources more productive, efficient, competitive, and profitable. It leads to cost reduction.
Allows management to monitor, control, and direct activities within the company. Performance standards act as incentives to perform more effectively.
Points out deviations between budget and actual, resulting in warning signals for changes or alterations.
Helps identify, on a timely basis, weaknesses in the organizational structure. There is early notice of dangers or departures from forecasts. The formulation and administration of budgets pinpoints communication weaknesses, assigns responsibility, and improves working relationships.
Provides management with foresight into potential crisis situations so alternative plans may be instituted.
Provides early signals of upcoming threats and opportunities.
Aids coordination between departments to attain efficiency and productivity. There is an interlocking within the business organization. For example, the production department will manufacture based on the sales department's anticipated sales volume. The purchasing department will buy raw materials based on the production department's expected production volume. The personnel department will hire or lay off workers based on anticipated production levels. Executives are forced to consider relationships among individual operations and the company as a whole.
Provides a motivational device setting a standard for employees to achieve.
Provides measures of self-evaluation.
Management can make distasteful decisions and blame it on the budget.
A budget can be disadvantageous because:
A budget promotes gamesmanship in that those managers who significantly inflate requests, knowing they will be reduced, are in effect rewarded by getting what they probably really wanted.
A budget may reward managers who set modest goals and penalize those who set ambitious goals that are missed.
There is judgment and subjectivity in the budgeting process.
Managers may consider that budgets redirect their flexibility to adjust to changing conditions.
A budget does not consider quality and customer service.
The signs of budget weaknesses must be spotted so that corrective action may be taken. Such signs include:
Managerial goals are off target or unrealistic.
There is management indecisiveness.
The budget takes too long to prepare.
Budget preparers are unfamiliar with the operations being budgeted and do not seek such information. Budget preparers should visit the actual operations firsthand.
Budget preparers do not keep current.
The budget is prepared using different methods each year.
There is a lack of raw information going into the budgeting process.
There is a lack of communication between those involved in budgeting and operating personnel.
The budget is formulated without input from those affected by it. This will likely result in budgeting errors. Further, budget preparers do not go into the operations field.
Managers do not know how their budget allowances have been assigned or what the components of their charges are. If managers do not understand the information, they will not perform their functions properly.
The budget document is excessively long, confusing, or filled with unnecessary information. There may be inadequate narrative data to explain the numbers.
Managers are ignoring their budgets because they appear unusable and unrealistic.
Managers feel they are not getting anything out of the budget process. Changes are made to the budget too frequently.
Significant unfavorable variances are not investigated and corrected. These variances may also not be considered in deriving budgeted figures for next period. Further, a large variance between actual and budgeted figures, either positive or negative, that repeatedly occurs is an indicator of poor budgeting. Perhaps the budgeted figures were unrealistic. Another problem is that after variances are identified, it is too late to correct their causes. Further, variance reporting may be too infrequent.
There is a mismatching of products or services.