The advantages of budgeting
/Formulating a budget is essential for many organizations. We note below seven advantages to developing a budget and then using it on a regular basis.
Advantage #1 - Planning Orientation
The process of creating a budget takes management away from its short-term, day-to-day management of the business and forces it to think longer-term. This is the chief goal of budgeting, even if management does not succeed in meeting its goals as outlined in the budget - at least it is thinking about the company's competitive and financial position and how to improve it.
Advantage #2 - Profitability Review
It is easy to lose sight of where a company is making most of its money, during the scramble of day-to-day management. A properly structured budget points out what aspects of the business produce money and which ones use it, which forces management to consider whether it should drop some parts of the business or expand in others.
Advantage #3 - Assumptions Review
The budgeting process forces management to think about why the company is in business, as well as its key assumptions about its business environment. A periodic re-evaluation of these issues may result in altered assumptions, which may in turn alter the way in which management decides to operate the business.
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Advantage #4 - Performance Evaluations
You can work with employees to set up their goals for a budgeting period, and possibly also tie bonuses or other incentives to how they perform. You can then create budget versus actual reports to give employees feedback regarding how they are progressing toward their goals. This approach is most common with financial goals, though operational goals (such as reducing the product rework rate) can also be added to the budget for performance appraisal purposes. This system of evaluation is called responsibility accounting.
Advantage #5 - Funding Planning
A properly structured budget should derive the amount of cash that will be spun off or which will be needed to support operations. This information is used by the treasurer to plan for the company's funding needs. This information can also be used for investment planning, so that the treasurer can decide whether to park excess cash in short-term or longer-term investment instruments.
Advantage #6 - Cash Allocation
There is only a limited amount of cash available to invest in fixed assets and working capital, and the budgeting process forces management to decide which assets are most worth investing in. In some cases, management may decide to sell off certain assets in order to generate enough cash to obtain other assets. This activity is closely aligned with the following item, bottleneck analysis, since cash should usually be invested in bottleneck operations before being invested anywhere else.
Advantage #7 - Bottleneck Analysis
Nearly every company has a bottleneck somewhere, and the budgeting process can be used to concentrate on what can be done to either expand the capacity of that bottleneck or shift work around it. This is an essential planning activity, since it impacts the throughput that a business can generate. Throughput is sales minus all totally variable expenses. If you cannot increase throughput via proper bottleneck management, then your business will not increase its profitability.
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