A budget is a document that translates plans into money - money that will need to be spent to get your planned activities done (expenditure) and money that will need to be generated to cover the costs of getting the work done (income). It is an estimate, or informed guess, about what you will need in monetary terms to do your work.

This process of financial planning known as budgeting.


Benefits of Budgeting

The budget is an essential management tool. Without a budget, you are like a pilot navigating in the dark without instruments.

  • Budgets set targets. It helps people to work towards a set target.
  • The budget tells you how much money you need to carry out your activities.
  • Budgets are a form of communication. Employees are aware of performance expectations with regards to their individual work area.
  • Budgets act as a monitoring and controlling tool. By doing a variance analysis the manager can estimate where actual results are different from the budgeted results.
  • Aid to the planning process by providing a series of quantitative guidelines which can be followed to achieve organisational objectives.
  • The budget forces you to be rigorous in thinking through the implications of your activity planning. There are times when the realities of the budgeting process force you to rethink your action plans.
  • Used properly, the budget tells you when you will need certain amounts of money to carry out your activities.
  • The budget enables you to monitor your income and expenditure and identify any problems.
  • The budget is a basis for financial accountability and transparency. When everyone can see how much should have been spent and received, they can ask informed questions about discrepancies.

Different budgeting techniques

The two main techniques for budgeting are incremental budgeting and zero based budgeting.

Incremental budgets

  • Incremental budgets are budgets in which the figures are based on those of the actual expenditure for the previous year, with a percentage added for an inflationary increase for the next year.
  • This is an easy method that saves time but it is the “lazy” way and is often inaccurate.
  • This budgeting technique is only suitable for organisations where each year is very similar to the previous one in terms of activities.
  • Very few dynamic organisations or projects are so stable that this budgeting technique really works for them.

Zero based budgets

  • In zero based budgets, past figures are not used as the starting point. The budgeting process starts from “scratch” with the proposed activities for the year.
  • The result is a more detailed and accurate budget, but it takes more time and energy to prepare a budget in this way.
  • This technique is essential for new organisations and projects, but it is also probably the best route to go in a dynamic organisation that is proactive in taking on new challenges.

Limitations of Budgeting

Though budgeting is major management activity, it has some useful functions for businesses and organizations, it does have great limitations.

  • Budgeting is a time consuming and costly job. The development of budget includes many repetitive steps before the budget is finally approved.
  • Compared with its costs, budgeting provides little valuable, reliable and relevant information.
  • Budgets are based on assumptions that often turn out to be inaccurate.
  • Budgets also cause great deal of waste and behavioral problems. People’s main goal is to meet the budgets, so they always try to negotiate to get lower targets with lower sales and higher costs, which are well known as padding the budgets.