USING BUDGETS

USING BUDGETS

1. ADVANTAGES

   • Monitoring performance
     • Budgets allow managers to monitor the performance of a business as a whole, as well as different sections and identify why some costs are higher/lower and good practice.
   • Identifying factors affecting performance
     • Prompt variance analysis allows managers to assess whether variances are caused by internal or external factors that can be corrected.
   • Improved plans in the future
     • By identifying variances and their causes, managers may be able to produce more accurate budgets in the future which will help planning and improve the performance of the business.
   • Improved accountability
     • Budgetary control in general helps to improve accountability in the business and can be linked to performance-related pay so that motivation is improved.

2. DISADVANTAGES

   • Motivation
     • In some businesses, workers are left out of the planning process and will therefore not be motivated by the budget.
   • Manipulation
     • Budgets can be manipulated by managers, for example setting low targets that are easily achieved so that the department looks successful, but doesn’t actually achieve the business objectives.
   • Rigidity
     • Budgets can sometimes constrain business activities, for example renewing machinery, which could reduce production and as a result lead to customer dissatisfaction.
   • Short-termism
     • Some managers may be too focused on the current budget and might take actions which undermine the future performance of the business just to meet current budget targets, making the business suffer in the long-term as a consequence.

3. Budgeting/Budgetary control: Involves a business using budgets to look into the future, stating what it wants to happen, and then deciding how to achieve these aims.

4. Preparation of plans

   • Targets are usually set which allow a business to determine whether its objectives have been met.

5. Comparison of plans with actual results

   • At the end of each budget period, the actual results can be prepared with the targets set in the budget to see how well the business is meeting its objectives.

6. Analysis of variance

   • Variance analysis involves trying to find reasons for the differences between actual and expected financial outcomes.