The benefits and limitations of budgets

Budgets are instruments of planning and control. Budgets
specify the expenses an employee or an organizational unit in an establishment is
authorized or permitted to incur for different types of activities or assets. Generally,
a budgetary planning and control systems includes some mechanism to restrict incurring
of expenditure exceeding the budget, and to monitor the actual expenditure against the
budgets. Thus, for example, budget of marketing department of a company may specify the
budgets under various accounts heads such as salaries, advertisement and travelling. The
marketing manager will have considerable freedom to take decisions in matter of number
of salesman to be employed, salaries to be paid to them, their travel cost and amount
spent on advertisement and promotion as long as the total expenditure under any head
does not exceed the budget. The manager may need to obtain special sanction for
incurring expenditure exceeding the budget. Also the actual expenditure incurred by the
marketing department will be periodically compared withe budgets, and the performance of
the marketing manager will be influenced substantially by the extent to which actual
expenditure are equal to or less than the budgets.

The
biggest benefit of a budgeting system is that it allows managers the freedom of decision
making as long as they do not exceed the budgets. It also enables a company to lay
standards of performance and levels of activities of different functions and departments
within the company. This ensures that various departments and functions operate within
the framework of a common overall plan. Budget also serves as a means of evaluating the
performance of different functions and managers within an
organization.

The biggest limitation of traditional
budgeting system is that it focuses primarily on expenses, paying little attention to
the results obtained as a result of the expenses incurred. Thus in the above example,
the marketing manager may fail to cash on an opportunity to sell more by increasing the
travelling of his sales-persons because that will lead to the travel expenditure
exceeding the budget.

The emphasis on input cost to the
inclusion of the consideration of results obtained makes budgeting quite meaningless
when the level of operations are very much fluctuating. For example, production cost in
any company are closely linked to the level of production. Therefore, a rigid budget,
that fails to take into consideration the level of production can become quite
inappropriate as planing or controlling tool.

Another
common problem of budgeting system is related to the way budgets are finalised. In many
organizations the budgets are often prepared on the basis of past performance rather
than the future requirements. This tends to create a false feeling of planned working,
when in reality the organization is only drifting along with the flow of past
trends.

There have been many attempts to overcome the
limitations of budgeting systems by introducing many innovations such as flexible
budgeting, zero based budgeting, and performance budgeting.