Study Notes: Business Finance & Accounting

Limitations of budgets

Whilst budgets are widely used to in business, you should appreciate that they have some important limitations.  In particular:

• Budgets are only as good as the data being used to create them.  Inaccurate or unreasonable assumptions can quickly make a budget unrealistic
• Budgets can lead to inflexibility in decision-making
• Budgets need to be changed as circumstances change
• Budgeting is a time consuming process – in large businesses, whole departments are sometimes dedicated to budget setting and control
• Budgets can result in short term decisions to keep within the budget rather than the right long term decision which exceeds the budget
• Managers can become too preoccupied with setting and reviewing budgets and forgetting to focus on the real issues of winning customers

Budgets can also create some behavioural challenges in a business

• Budgeting has behavioural implications for the motivation employees
• Budgets are de-motivating if they are imposed rather than negotiated
• Setting unrealistic targets adds to de-motivation
• Budgets contribute to departmental rivalry - battles over budget allocation
• Spending up to budget: it can result in a “use it or lose it” mentality - spend up to the budget  to preserve it for next year
• Budgetary slack occurs if targets are set too low
• A “name, blame and shame” culture can develop - but managers should be answerable only for variations that were under their control