A budget can be described as a financial plan for a business that has been prepared well in advance to demonstrate and dictate the future course of work of a business.
A budget may be set in money terms or it can be expressed in terms of units. Budgets can also be put across in the form of income budgets for money received i.e. sales budget, or expenditure budgets for money spent, i.e. a purchases budget. However, a major emphasis has always been on the cash budget which combines both income and expenditure in estimating the business working capital, cash in hand and bank balance during a course of work or a time period.
The budgets are usually prepared for the following financial years (budget period), and are usually broken down into shorter time periods in order to emphasize on the figures and their attainment/fulfillment. The periods are usually monthly or quarterly, determined based on the level of activities and its operations. This ensures budgetary control to be exercised over the budget; the actual results can be monitored against the budgeted figures. In case, of better performance the organizations announce bonus, give increments to its employees however, in case of unfavorable figures, the discrepancies between the two can be investigated and corrective action can be taken accordingly.
Advantages of Budgets
Budgets provide benefits both for the business, and also for its managers and other staffs:
- The budget assists planning – Once the business objectives are set and formalized through a budget, it can b ensured that the other business plans are also achievable. It also helps in taking the output decisions of various goods and services and to make sure that everything is available at the right time.
- The budget communicates and co-ordinates – A budget is agreed by the business, and helps the different department and sections within work towards a same end. It helps in maintaining a discipline throughout and in assuring that all departments play in their own part in achieving the goal. The budget once set also helps in resolving any anticipated problems and other areas of potential confusion get clarified.
- The budget helps in decision-making process – As already own a budget helps in planning ahead and thus allowing the business to think an foresee ahead of time, they cannot only decide the form of goods and services to be served but also the purchase decisions which can help it in manipulating its prices.
- The budget can be used to monitor and control — The most important benefit of a budget preparation is helping a management to have budgetary control to monitor and compare the actual results. This further helps in adapting various actions in modifying the operations of the business as time passes, or possibly to change the budget if it becomes unachievable.
- The budget can be used to motivate and control — A budget often acts as a motivating factor since provides the managers and other staffs a predetermined goals. This not only helps the business but also helps its employees since on fulfillment of the predetermined targets most of the organizations declare various types of bonuses and increments for its staff.
Disadvantages of Budgets
Though there are various benefits to the fact of budget and budgetary control, however, there are few limitations also and these are described below:
- Benefits of producing a budget should exceed its cost – Budgeting is fairly a complex process and for some businesses especially the small ones it may pose too much of a burden in terms of time and other resources, with only limited benefits. Nevertheless, most of the lending organizations such as banks etc. in today’s era often require the budgets as part of the business plan in order to further proceed with their lending or investment decisions. In these cases, as a general rule, the benefit of producing the budget must exceed its cost.
- Budgets are often not accurate – Budget deals with estimations and predictions relating to future based on the figures of the past and the present. Therefore, a great risk is involved with it tending the figures to be wrong. A business highly dependent on budgets may found it difficult to succeed with wrong details put across. Therefore, great care needs to be taken with estimation of various facts and figures. Budgetary control is used to compare the budget against what actually happened — the budget may need to be changed if it becomes unachievable.
- The budget might demotivate – Employees at the ground level who do not possess any managerial rights or does not take part in agreeing and setting on to a budget might felt to be imposed upon them and thus might act as a demotivating factor. Instead of encouragements it might pose a threat to employees since a non-attainment of the target might bring in some sort of difficulty for the employee.
- Budgets might lead to dysfunctional management – The targets might pose in a threat with employees in one department of the business achieving more than their budgeted targets and create problems elsewhere. For example, a production department might achieve extra output that the sales department finds difficult to sell. The might create a chaotic situation and to avoid such dysfunctional management, budgets need to be set at realistic levels and linked and co-ordinated across all departments with proper informations.
- Budgets might be set at too low levels – Budgets being prepared by individuals can be prepared at low achievable rates since, the budget where too easy to achieve, will be of no benefit to the business and may, in fact, lead to lower levels of output and higher costs than before the budget was established. Budgets should make it sure, the best use of the resources available.