In this article, we’ll explain all the roles that budgets can play within an organization to understand the problems that can arise when they are not used effectively.
Planning
Organizations that have money to invest in new projects may use budgets to model the financial outcome or effectiveness when choosing a particular option. Also budgets are used to plan ahead and analyze the financial position of a company in one, two and sometimes 15 years ahead.
By planning ahead it is possible to predict labor as well as material requirements. Planning also includes predicting future problems.
Communication
Budgets enable organizations to work towards common financial goals. As all departmental (functional) budgets will together form the master budget, it is possible to ensure cost control at an organization level.
Communication within large organizations can often be neglected. A budget can provide a means of fostering communication across the organization, by ensuring employees and managers both understand the goals of the organization. This only works if the members of the organization know how budgets work.
Communicating budgets across the organization allows all managers to understand what and why resources are being used in different areas of the business.
Coordination
Using a master budget provides a structured framework for the financial needs of the whole organization. If a master budget was not used you could end up with different departments working towards their own goals, rather than the targets of the company.
Co-coordinating through the use of budgets can result in resources being used effectively in the right areas.
Motivation
It has been recognized that if budgets are used appropriately they can be motivational. In general it is agreed that managers who are educated and are involved in the budget-setting process will work harder towards achieving the goals of the organization.
Motivational benefits depend on whether the budgets are viewed as a threat or as a challenge.
Control
Organizations that use budgets to monitor performance are using the budget as a control device. They set targets at the beginning of the year and assess how the individual managers have performed that year by using variance analysis. Of course, if used incorrectly, this technique can in fact demotivate employees and managers.
There are many roles of budgeting, it should be noted that not all budgets are expected to deliver all of these roles.