Study notes

Budgets - Limitations and Potential Problems

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

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