The Disadvantages of an Adverse Budget
Preparing budgets for an organization or project is a complex process, and one that often isn't perfect. The difference between a budget plan, or static budget, and the actual cost and income results, called the flexible budget, is known as budget variance. When a budget variance is unfavorable, it is an adverse variance. Comparing the plan to the reality creates an adverse budget, which has a number of negative implications for the organization.
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Income Reduction
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While project budgets don't account for income, budgets for businesses and other organizations do. One major drawback of an adverse budget is that it may indicate a reduction in income compared to expected levels. This leaves the organization with a choice between taking aggressive steps to boost income in the future or preparing future budgets that rely on lower income estimates. If income remains low and budget variance becomes more adverse, it can become impossible for a business to make a profit.
Cost Overrun
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Another disadvantage that an organization or project manager with an adverse budget faces is cost overrun. Even if income meets expected levels or isn't part of the budget equation, excessive costs will cause an adverse variance. Controlling costs is another key to profitability. Projects that exceed budgeted costs run the risk of early cancellation and those who oversee them develop reputations for not being able to deliver on budget.
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Borrowing Requirements
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When an organization has an adverse budget variance, it will need to come up with ways to cover the additional costs. This may cut into cash reserves, or it may necessitate additional borrowing. Taking out loans to pay adverse budget costs creates long-term liabilities and adds the cost of interest to future budgets. Borrowing on short notice prevents a business from seeking the best rate and comparing options. This is how adverse budgets can affect future projects even after they're closed.
Budget Planning Issues
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Regardless of the circumstances, an adverse budget indicates a potential problem in the budget planning process. While variance is to be expected, consistent or especially large adverse budgets reveal an inability to accurately project costs and forecast income. This may indicate deeper problems with an organization's leadership and financial structure. For example, a project manager who fails to account for added payroll to cover overtime costs as employees near the deadline for a project doesn't have a full understanding of the process and the costs it entails.
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