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    Controller Library Value Pack
    CFO Library Value Pack
    Accounting Standards Library
    Thursday
    Dec092010

    What are the advantages of budgeting?

    The advantages of budgeting include:

    • 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.
    • 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.

    • 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 managements decides to operate the business.
    • 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.
    • 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.
    • 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.
    • 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 to shift work around it.

    Related Topics

    What are the disadvantages of budgeting?
    What are the objectives of budgeting?
    What are the steps in preparing a budget?
    What is a budget?

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