The budget does not represent business reality - it is merely a map describing where the business is going. A major mistake that often occurs with the budgeting process is thinking that money allocated to a certain expenditure actually exists in the bank. Effective business owners constantly check the budget against operational reality and make changes in the budget as needed. Flexible budgeting in response to actual business performance is the mark of a shrewd businessperson. Too rigid adherence to the budget often leads to poor profit performance and even bankruptcy.
Budget is used as a control device.
Controlling expenditures is essential if a profit is to be realized. The budget is the single most important device available for monitoring and controlling expenditures. Any business will eat up resources. Actual expenditures are compared against budgeted expenditures. Monthly and annual expenditure comparisons must be made for both control and flexibility purposes.