As a company grows and transactions increase in number and complexity, it makes good sense to prepare a budget�??a detailed plan showing how resources will be used during a given period of time, usually a year.

What are the benefits of budgeting?

First, it encourages the manager to think systematically and plan for the future. Running a business entails more than just dealing with day-to-day operations. One has to ensure that the business remains viable and sustainable. Therefore, knowing what and where certain business endeavors should be accomplished is key.

Second, a budget helps the manager decide how to allocate the business’ scarce resources. For instance, if excess cash was available and the manager is choosing between paying off high-interest loans or investing in additional inventory to increase revenues, he may project budgets for both scenarios and pursue whichever option has a more positive effect on the bottom line.

Third, a budget provides standards for evaluating performance. Targets are compared with actual results and differences or variances between the two are identified and analyzed so that the company can take corrective action. For example, if actual sales were significantly below the budgeted level, the manager is alerted to study the possible reasons for the shortfall.

Fourth, a budget, especially in its preparation, “forces�? company personnel with different responsibilities to work together toward achieving common goals. The salespeople might aim for increased sales, for instance, which may involve a related increase in manpower. On the other hand, the human resource people might be aiming for lower costs through a hiring freeze. The budget will then have the effect of unifying these seemingly opposing goals so that, in the end, these company personnel find a way to achieve whatever is agreed upon to be the best for the company.

Moreover, a budget serves as a communications tool to exchange information about the company’s goals as well as achievements. It also creates awareness among company personnel on how each activity contributes to the company’s overall performance.

Finally, a budget, if used properly, provides the manager the motivation to work harder to achieve the projected results.