Budgeting is an important exercise that is followed in almost all organizations. Although budgeting has a lot of advantages, it has a few limitations, which are highlighted in the article.
Limitations of Budgeting
Budgeting is based on a lot of assumptions in estimating expenses and revenues. These are generally based on trends and the market scenario prevailing when making the budget. Budgets can also be based on the predictions made for the coming year considering the data available at the time of budgeting.
Any shift in the macroeconomic conditions, like an economic downturn or changes in currency exchange rates, changes in interest rates, etc., can lead the actual costs to vary significantly from the budgeted expenses.
Time-Consuming & Costly
Budgeting exercise can be, at times, a very time-consuming exercise. It involves an extra workforce to get the estimates as accurate as possible. Especially for a big company with various departments, budgeting exercise takes a huge effort. The time consumed may be low in cases where the company uses budgeting software and the employees are well-trained. If the company uses a zero-based budgeting technique, the time, cost, and effort involved can be considerably large.
Budgeted numbers are considered sacrosanct by all the departments. And there is usually very little flexibility after the budgeting exercise finishes. The entire focus of senior management is on the budget, and all the strategies revolve around the budgeted numbers. Any change in the market situation does not generally evoke the management’s attention to make any drastic change in the strategy due to budget constraints. Instead, the company should shift as per the market and book more profit rather than stick to the budget.
Some managers believe that all the funds that are allocated to their department need to be spent. It is believed that if they do not use as much as they are authorized to in the current budget, the funds budgeted for them in the next budget will be reduced. This leads to unnecessary wastage of funds and proves harmful to the company, affecting its profits.
Scope for Manipulation
At times, an experienced manager may deliberately inflate his expenses and try to reduce the revenue targets to be set in the budget. This way, he can easily get an opportunity to get favorable variances against the budgeted numbers, that is, by incurring lower costs than budgeted costs and achieving higher revenue than the budgeted revenue. This misleads the stakeholders and demotivates the employees.
Allocation of Expenses
The allocation of expenditure between the departments is generally the call senior management takes. Managers of some departments may raise issues in the method used for the allocation of these expenses, and this may create controversies. It is not possible to consider suggestions from all the departments regarding budgeting methods and allocation of expenses.
Financial Outcome Oriented
The budgeting exercise is argued to be number-driven. It focuses on the quantitative aspect of the business or improving the company’s profitability. And does not consider the subjective or qualitative aspect. The fact that the stakeholders, including the customers of the company, care about the quality of services along with the cost of it is totally side-tracked. These are taken for granted as a part of the budget but not really seen in the budget. So budgeting exercise does not always look into the needs of the customers.
Conflicts in the Organization
At times when a particular department is unable to meet the budgeted targets, they end up blaming the other department that provides services to it for not providing the necessary support. They even conflict on the transfer price that is decided internally between the departments. This creates unnecessary tensions, and the company as a whole may not be able to run efficiently.
Although budgeting comes with many limitations, it may be absolutely wrong to conclude that budgeting exercise is futile for an organization. It keeps a department tied up and restricts its freedom. But to some extent, it does bring about some discipline within the departments in terms of the expenses they incur during an accounting period.
Considering all the disadvantages of budgeting, it is the decision of the top management how to do the budgeting exercise and optimize the cost to a company while setting up the budget.
Quiz on Limitations of Budgeting