What is a Performance Budget? Definition, Example, Advantage, and Limitation

Definition

Performance-Based Budgets are focused on outcomes and targets set for the organizations.

It can be referred to as preparing a budget to evaluate productivity across different operations.

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

Performance-based budgets are mostly resulting and outcome-oriented. Therefore, the main criterion used to gauge these budgets’ efficacy is based on the eventual outcome and contribution to the organization.

Example

Performance-Based budgeting involves setting targets to meet the objectives of the organization, at large.

For example, the target might be to reduce the company’s overhead expenses by a certain amount. In this regard, the company’s objective will be to control its 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 that these criteria have been by the company at the year-end.

Purpose

The main purpose of drawing up Performance Budgets is to meet the targets. This is important for companies, especially when businesses tend to face stiff competition from external forces, in terms of increasingly complex marketing dynamics.

It can be seen that it has now become necessary for a business to work on their actual performance so that they can survive in the existing economic landscape.

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

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For example, if the sales department has a performance budget of increasing sales by 30%, they would work towards this aim.

Similarly, 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 that it helps the companies identify accountable personnel and departments that are not performing up to the mark.

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

Similarly, performance budgets also help establish a clear and concrete approach that can help companies assess their performance.

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 they reason that it contributes positively to 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 to achieve the required budget.

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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 demotivate the employees if targets are not met.

Similarly, they are also difficult to implement and execute in the longer term. This can only be done over a shorter period.

Setting up performance budgets is an increasingly complex challenge because it constitutes subjectivity.

It is a complex task to set up thresholds, which might backfire on the organization if set incorrectly.

It also requires organizations to have strong accounting systems to ensure that companies can meet their respective targets and objectives.