Why do we need Budgets?

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Businesses carry out the budgeting exercise yearly to ensure that they have a set of performance data that they can use as a guide to operations in the coming year. However, in an article by PwC (FSI, 2010), they claimed that “Executives and other stakeholders have long vilified the budgeting and planning processes“. As a financial executive doing budgets year in year out, I too found it perplexing that since it will never be accurate why even bother? In fact, I would say that before the new period or financial year arrives, it will be obsolete already given how fast the business environment changes in recent times. Akten (2009) noted that in these times of economic volatility there is a need for faster budget processes more closely connected to strategy through the CFO’s active intervention so that despite the special challenges, companies can greatly improve their chances of coping with the uncertainty they now confront.

As a consultant and a trainer looking in from the outside now, I believe that budgets or the process of budgeting still have a role to play in financial management and this is on top of the obvious role of having a set of information to monitor actual performance against. The important part of budgeting is not the pieces of paper the budget is printed on (like an emperor’s edict of old) but the process. Going through the process makes use look closely at what we can do in order to achieve the organization’s short term objectives. If we did not do budgeting and debated the pro and cons of the activities to be budgeted how are we to know which path is the correct one? For example; without budgeting or the development of a sales budget, how would production know how much resources to garner for the next year’s production and what they should be producing? Budgeting forces us to map out our journey for the next period.

Another benefit of the budgeting process is the need to communicate information such as availability of resources, production capacity, human resources availability, sales levels and other crucial information at the budgeting stage. The sharing of such information and the verification thereof during the budgeting stage can be an excellent practice session for improving coordination and linkages between various department and reducing interdepartmental friction. Activities will tend to be better coordinated in the actual operational period. In Addition, targets set during budgets are also good motivational tools for managers to improve their ability to manage revenues and cost. When they are involved in the process of setting the targets, they tend to take ownership of the responsibility of reaching those targets . Such targets can also be used as realistic performance appraisals KPIs.

So, don’t ditch the budget yet even though to some its cumbersome and costly as it is still useful in a corporate setting. A budget as it is, provides a benchmark against which actual performances can be measured  but as we can see above, it’s processes provides much more benefits to the organizations.

Akten, M., 2009. Just-in-time budgeting for a volatile economy. [Online]
Available at: http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/just-in-time-budgeting-for-a-volatile-economy
[Accessed 23 March 2016].
FSI, 2010. Breaking the Cycle: The Case for Eliminating the Budget. [Online]
Available at: http://www.pwc.com/us/en/financial-services/publications/viewpoints/viewpoint-eliminating-budget.html
[Accessed 23 March 2016].
By Dominic Shum,  12 April 2016- Revised  5 May 2016