Table of Contents
- 1 What is Performance Budget?
- 2 Process of Performance-based Budgeting
- 3 Performance-based Vs Traditional Budget
- 4 Example of Performance Budgeting
- 5 Advantages of Performance Budget
- 6 Disadvantages of Performance Budget
What is Performance Budget?
Performance budget also referred as performance-based budgeting is a practice of preparing the budget based on the evaluation of the productivity of the different operations in an organization. Operations which are contributing the most to the profitability, the larger share of the budget is allocated to that division. It leads to optimum utilization of resources such as finance, skills of the staff, use of the productive time etc.
Basically, performance budget requires an evaluation of the performance and productivity from one budget period to another budget period. It is the process of identifying the results achieved by each division of the organization.
Further, performance budget does not focus on the individual activities which are necessary for developing strategies. Instead, the core focus is the achievement of the overall goal of the division. This helps the managers to frame the strategy of the division. Performance budgeting is based on the concept of zero-based budgeting.
Generally, not for profit organization and the government departments use performance budget. It is used to justify the application of money. Not for profit and government earns through taxes levied on the citizen and lake of correct information may result in ineffective performance budget which affects the entire project.
Performance Budget focuses on the “results”. The final outcome is analyzed. Performance budget is a motivating tool for the staff.
It asks the question that “Why the money is being spent?”
Process of Performance-based Budgeting
The organization shall make the list of the goals. The goal here indicates the end result. The goals should be clear to each employee of the organization. Clear goal and communication of the same results into successful implementation of performance-based budgeting.
Thus, this step is planning and budgeting.
The next step is the periodic evaluation of the performance to achieve the desired goals of the organization. The organization shall develop a systematic step by step approach for evaluation. Performance measurement is subjective which differs from person to person. The organization shall try to quantify the result based on the outcomes.
Thus, this step is a measurement of results.
Performance indicators help in evaluating the effectiveness and the efficiency of the program. A performance indicator is a standard for measurement. The selection is based on the extent of following:
- It’s relevance
The organization is going to be accountable for the result or outcomes. The primary focus of performance budget is the outcome and not the inputs. The staff is accountable for organizational goals. Besides, performance-based budgeting expects to achieve a level of results based on the given level of resources.
Thus, this step is called evaluation and communication of results.
Performance-based Vs Traditional Budget
The amount to be spent for the particular purpose for example on staff salary, office supplies, equipment etc. are included in the traditional budget. However, what is to be accomplished by each dollar spent is indicated by the performance budget. Previously, the organizations were not following performance-based approach. However, currently, the organizations follow performance-based approach.
Example of Performance Budgeting
- 30% reduction in death ratio of HIV-Positive patients by the end of 2020.
- 20% increase in production in 2018 by staff training on a monthly basis.
- 50% reduction in infant mortality rate by implementing robust vaccination centers in all different parts of the country by 2022.
Advantages of Performance Budget
In the advanced world, the management of the money becomes one of the important factors for any organization. The performance budget plays an important role to achieve the efficiency.
In the public sector organization and not for profit organization, performance budget helps to increase the accountability. The employees have to quantify a particular goal based on the priority and the tax payer’s money. Unquestionably, taxpayer and the donors have interest in knowing where the money is spent. It evaluates the benefit accruing to the citizens and society.
Performance budgeting indicates clearly the objective on which the money is going to be spent. By making the purpose clear, it becomes easier to assess the performance and correct the deviations.
Improvement in Performance
The performance budget improves the performance of the programs on a continuous basis. It leads to the overall operational efficiency of the organization. Performance budget overcomes the limitations of traditional budgeting.
Performance-based budgeting helps in bringing the transparency in the budget preparation. The performance budget helps in taking better financial decisions for the allocation of resources. The performance budget reviews the operational efficiency of the projects. Hence, one can say, it links the entire process of planning, implanting and evaluation of the results.
Disadvantages of Performance Budget
Since the performance budget is subjective in nature, it creates disagreement amongst the management. Social projects are with a long-term vision. It is difficult to quantify in money terms. The costs may differ from one government body to another government body.
Therefore, The more use of result based approach helps in improvement of the budgetary process, accountability, and administration of the organization.
Strong System of Evaluation
The performance budget requires a strong system of accounting. Therefore, The reporting system has to be strong for successful implementation of performance budget.
Manipulation of Data
Staff may manipulate the data. Further, the calculation of the financial information is not reliable because of the errors in preparation.
Therefore, Proper internal control system helps in maintaining the accuracy of the data.
Difficult for Long-term
The time period between the allocation of resources in the project and the achievement of the result might be more than a year. Undoubtedly, it makes difficult to measure the results of the projects in long-term.
Therefore, Dividing the project into small parts may help in simplifying the evaluation process.
Without a doubt, over a period of time Performance Budget became popular overall in the industry.