There are various ways to create a budget for your small business. Choosing one over another depends on your goals. Performance budgeting, for example, focuses on a company's results rather than its expenditures. It is commonly used by private and public organizations, leading to optimum utilization of resources. This type of budget helps define the purpose for which funds are required.
What Is Performance Budgeting?
Drafting a budget is essential for business growth and development. When done right, it can help you anticipate future needs, profits, expenses and revenue. It also makes it easier to identify potential problems before they escalate. A performance budget takes into account your company's activities and projects. Think of it as the process of identifying, analyzing and defining specific performance objectives of a project to be completed within a particular time frame. This budgeting technique has been linked to improved expenditure control, higher efficiency and greater performance.
Be aware that performance budgeting isn’t the same thing as zero-based budgeting (ZBB). Even though both require organizations to rigorously manage financial performance, they involve different practices. The best way to define zero-based budgeting is by starting with a balance of zero, with no references being made to your company's past or actual performance. Every functional area of the organization is reviewed from scratch and every new expenditure requires approval. Performance-based budgeting, by comparison, focuses on targets and offers the flexibility to allocate funds when conditions are met. It aims to improve the efficiency of a company's expenditures, boost employees' commitment and provide accountability.
Performance Budgeting Advantage: Allows for Better Cost Estimates
A performance budget allows for better estimates of costs in each department. Also, it enables companies to allocate funds to various projects by their importance. The public sector, for instance, has to show citizens that their money is well spent. Therefore, it provides regular updates on the goals of each project and the steps needed to complete it. The budget model example described above may address various outcomes, such as reducing non-violent crime in a city or restoring a historic landmark.
Performance Budgeting Advantage: Find Areas for Improvement
Private and public organizations use performance information to determine what's working and what could be improved. Then they set clear objectives and develop a strategy to achieve the outcome. The allocation of funds is based on specific goals and indirectly related to past performance or proposed future performance.
Performance Budgeting Advantage: Cuts Unnecessary Expenses
Performance budgeting can help reduce unnecessary expenses and provide a framework for achieving your business goals. Furthermore, it helps to define the purposes and objectives for which money is required. By using this budgeting method, you will find it easier to estimate and justify the potential outcomes of new funding decisions.
Performance Budgeting Disadvantage: Where Should the Money Go?
A common concern about performance budgeting is that a company's employees and executives may have different ideas regarding what's important and where the funds should go. Since this budgeting method is goal-oriented, there is no qualitative evaluation. Also, it can be difficult to determine how well a specific department or team will be performing. What looks good on paper may not work in the real world.
Performance Budgeting Disadvantage: Easy to Manipulate
Another disadvantage is that one department or another could manipulate data to reach specific targets and receive funding. In this case, an independent party may need to analyze its performance, which further increases the costs involved. Plus, performance budgeting may not work for long-term projects. Breaking the project into smaller parts can help simplify the reporting process.