Budgets are important to businesses for numerous reasons. The reasons are essentially based on the role of budgets. These reasons include:

• Planning - The budgeting process helps decision makers to plan their operations based on the amount of money they have been allocated in the budget per time period.

• Forecasting - Budgets help businesses to plan the timing of their expenditure based on the planned revenue streams. This can help the organization to improve its cash flow forecasts and liquidity position.

• Prioritizing - It forces budget holders to prioritize their activities, e.g., which members of staff to send on training and which courses to send them on.

• Controlling - Enables managers to identify and analyse differences in planned and actual revenues and expenditure. This helps them to better understand possible financial problems and to devise corrective actions.

• Target setting - Budgets help departments within a business to set financial goals, thereby preventing costs spiralling out of control.

• Motivating - Empowering budget holders can act as a form of motivation (see Unit 2.4), especially if there are financial rewards linked to the attainment of financial targets such as sales revenue.

• Accountability - Budgets make people accountable for their actions and spending. Formally monitoring this through budgetary control is important, especially in organizations with a laissez-faire management or leadership style (see Unit 2.3).

• Benchmarking - They provide a basis for measuring the degree of success or failure (see section on variance analysis below). Managers can see if cost and/or revenue targets are met and to and take corrective actions if need be.

However, there are limitations of budgets too, which include the following:

• Costs and time - Preparing, constructing, setting, and updating budgets may be expensive and time-consuming.

• Demotivational - If budgets are inflexible and unrealistic, regardless of changes in circumstances, staff may become highly demotivated.

• Changes in the external environment - Similarly, setting realistic budgets may be difficult in a dynamic business exposed to the constant forces of change. Hence, budgets could be a waste of time and resources.

• Sub-cultures and conflict - The culture of many organizations is that budgets are often related more to power and status, than to the needs of the business. Department budget holders may exaggerate budgets to elevate their position in the organization.

• Inaccuracies - Budgeting is only based on forecast costs and revenues, so may turn out to be rather inaccurate.

• Profligacy - This refers to reckless expenditure or wastefulness in the use of resources. In organizations that do not allow budgets to be carried over to the financial year (to prevent overspending), budget holders may feel the need to spend towards the end of the financial year rather than having the money taken away by the master budget holder.