- Budgeting puts pressure on managers to do better forecasting. Managers should be constantly scanning the business environment to spot changes that will impact the business. Vague generalizations about what the future may hold for the business aren’t good enough for assembling a budget. Managers are forced to put their predictions into definite and concrete forecasts. For example, here’s a sample of costs that a business should forecast:
- Wages and salaries
- Insurance (health, business owner policies, workers’ compensation)
- Utility costs
- Shipping costs
- Interest rates
- Travel and entertainment
- Technology (software, hardware, and consultants)
- Legal fees, rents, and audits
- Budgeting motivates managers and employees by providing useful yardsticks for evaluating performance. Involving managers in the budgeting process (especially in setting goals and objectives) can give managers incentives to strive for the business’s goals and objectives. Budgets provide useful information for superiors to evaluate the performance of managers and can be used to reward good results. Employees may be equally motivated by budgets. For example, budgets supply baseline financial information for incentive compensation plans. And the profit plan (budget) for the year can be used to award year-end bonuses according to whether designated goals were achieved.
- Budgeting can assist in the communication between different levels of management. Putting plans and expectations in black and white in budgeted financial statements — including definite numbers for forecasts and goals — minimizes confusion and creates a kind of common language. As you probably know, the “failure to communicate” lament is common in many business organizations. Well-crafted budgets can definitely help the communication process.
- Budgeting is essential in writing a business plan. New and emerging businesses need to present a convincing business plan when raising capital. Because these businesses may have little or no history, the managers and owners must demonstrate convincingly that the company has a clear strategy and a realistic plan to make profit. A coherent, realistic budget forecast is an essential component of a business plan. Venture capital sources definitely want to see the budgeted financial statements of a business.
Likewise, unfavorable variances have to be interpreted carefully. If a manager’s budgeted goals and targets are fair and reasonable, the manager should be held responsible. The manager should carefully analyze what went wrong and what needs to be improved.
Stern action may be called for, but the higher-ups should recognize that the budget benchmarks may not be entirely fair; in particular, they should make allowances for unexpected developments (such as a hurricane or tornado, or the bankruptcy of a major customer) that occur after the budget goals and targets are established. When managers perceive the budgeted goals and targets to be arbitrarily imposed by superiors and not realistic, serious motivational problems arise.