Performance Budget: Definition, Example, Advantage and Limitation

Definition

Performance-Based Budgets are budgets that are focused on outcomes, and targets that are set for the organizations. It can be referred to as a practice of preparing the budget that is based on evaluating productivity across different operations within an organization.

In this regard, the rule of thumb is to allocate budgets to departments depending on their contribution within the organization.

Performance Based budgets are mostly result and outcome oriented, and therefore, the main criterion that is used to gauge the efficacy of these budgets is based on the eventual outcome and contribution towards the organization.

Example

Performance-Based budgeting involves setting targets in order to meet the objectives of the organization, at large. For example, the target might be to reduce the overhead expenses of the company by a certain amount. In this regard, the objective of the company will be to control their expenses to meet a certain level.

Alternatively, it can also be seen that the objective or the Performance Budget set within the company might be to increase sales of the company by 30%.

This means that the criteria for evaluating the effectiveness of this budget are solely going to rely on the fact if these criteria have actually been by the company at the year-end.

Purpose

The main purpose of drawing up Performance Budgets is to ensure that the targets are met. This is important for companies, especially in the cases where businesses tend to face stiff competition from external forces, in terms of increasingly complex marketing dynamic.

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As a matter of fact, it can be seen that it has now become necessary for a business to work on their actual performance so that they are able to survive in the existing economic landscape.

Therefore, with performance budgets, companies are able to structure their efforts towards something more concrete, since they have a clear cut idea regarding the objectives they need to achieve.

For example, if the sales department has a performance budget of increasing sales by 30%, they would work towards this aim. In the same manner, if the procurement department is instructed to lower the purchase costs by 10%, they would be expected to follow the same protocol.

Hence, it can be seen that the main purpose of performance budgets is based on the criteria to ensure that all the relevant criteria are duly met, so that there is no confusion relating to the objectives of the respective departments. It helps them to work with a target in mind, rather than an otherwise haphazard approach to carry out their functions.

Advantages of Performance Budgets

The main advantage of Performance Budgets is the fact that it helps the companies to identify accountable personnel and department within the company which is not performing up to the mark.

This idea of accountability tends to be impactful because of the reason that it helps create a sense of responsibility within the company, which tends to have promising outcomes for the company.

In the same manner, performance budgets also help to establish a clear and a concrete approach that can help companies to assess their performance.

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At the end of the reporting period, they would be enabled with areas that require concentration in terms of strategy as well as execution.

These factors help to ensure that the overall performance is improved across the organization because of the reason that it contributes positively in terms of stretching their limits.

This tends to extrapolate better results, because all the departments, as well as the personnel within the company within the organization, tend to work with the aim of achieving the required budget.

Limitations of Performance Budgets

However, there are certain limitations of performance budgets that should also be considered. Firstly, it can be seen that it might lead to counter-productivity in the long run, because of the excessive pressure to fulfill these budgets.

It might also lead to demotivating the employees in case targets are not met.

In the same manner, they are also difficult to implement and execute in the longer term. This can only be done over a shorter time period. Setting up performance budgets tends to be an increasingly complex challenge too because it constitutes subjectivity.

As a matter of fact, it is a complex task to set up thresholds, and it set incorrectly, it might backfire for the organization. It also requires organizations to have strong accounting systems that can ensure that companies can meet their respective targets and objectives.

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