How do performance budgets work?

Performance budgets work by allocating resources based on the expected results or outcomes of different business activities.

A performance budget is a type of budget that reflects both the input of resources and the output of services for each unit of an organisation. It is a powerful management tool for planning, controlling, and evaluating the performance of an organisation. The main idea behind a performance budget is to link the funding of a business unit with its performance outcomes, rather than just its financial inputs.

The process of creating a performance budget involves several steps. First, the organisation needs to identify its goals and objectives. These goals could be anything from increasing sales by a certain percentage, reducing costs, improving customer satisfaction, or any other measurable outcome. Once the goals are set, the next step is to determine the resources needed to achieve these goals. This includes both financial resources, such as money, and non-financial resources, such as staff time or equipment.

The organisation then allocates these resources to different business units or activities based on their expected contribution to achieving the goals. This allocation is done in a way that maximises the overall performance of the organisation. For example, if one business unit has a higher potential for increasing sales than another, it might receive a larger share of the resources.

Once the budget is set, the performance of each business unit is monitored and evaluated based on the outcomes they produce. If a business unit is not meeting its performance targets, it may have its resources reduced in the next budgeting cycle. On the other hand, units that exceed their performance targets may receive additional resources.

In summary, performance budgets work by linking the allocation of resources to the expected results of business activities. This approach encourages efficiency and effectiveness in the use of resources, and provides a clear link between funding and performance.