Budgeting

Budgeting for business play an important role in management control system. It gives a brief understanding about what are budgets, what is budgeting and different types of budgeting methods i.e. zero based budgeting, incremental budgeting, traditional budgeting and activity based budgeting.

Before we understand the different types of budgeting methods, let us understand the meaning of budget.

What is a Budget?

A budget is a written estimation of the financial performance of a particular department, a specific project, a business unit or an organization. The comparison of budgeted performance with actual performance provides an indication, if something is going wrong and requires immediate attention. There are different budgeting methods in accounting.

What is Budgeting?

Primarily, the activity of preparing a budget is called budgeting. In many organizations, budgeting is a separate department taking care of only preparation and implementation of budgets. The comparison of budgeted performance with actual performance provides an indication, if something is going wrong and requires immediate attention.

The purpose of this article is to highlight different budgeting methods and procedures.

Types of Budgeting Methods

Budgeting

Listed below are the most popular types of business budgeting methods.

  • Zero based budgeting
  • Incremental budgeting
  • Traditional Budgeting
  • Activity Based Budgeting

What is Zero-Based Budgeting Method?

Zero based budgeting is a commonly used budgeting method. In ZBB, current year’s budget is prepared from the scratch, without considering the budget of the previous year. For every financial period, a fresh budget is prepared taking the base as zero and resources allocated to each department are justified according to the expenses of that particular period. The ranking for allocation of resources is on the basis of priority of all the activities of the business. Though this method is time consuming, but it gives accurate results.

To have a detailed understanding of the method and its pros and cons visit – Zero Based Budgeting

What is Incremental Budgeting Method?

Incremental budgeting is a budgeting method where current year’s budget is prepared by making changes in the past year’s budget. The changes are in the form of addition or reduction of expenses to last year’s budget. In Incremental budgeting, the starting point for preparing budget is prior period’s budget. The budgeting technique gives no priority to vital activities of business. We simply adjust last year’s budget considering the inflation factor. This is a quick and easy method of preparing budgets.

For a detailed understanding of the advantages and disadvantages visit – Incremental Budgeting,

What is Traditional Budgeting Method?

Traditional budgeting is a budget preparation method which considers last year’s budget as the base. Current year’s budget is prepared by making changes to previous year’s budget by adjusting the expenses based on the inflation rate, consumer demand, market situation etc. Current year’s budget is prepared on the basis of the past year’s revenues and costs. Only those items in traditional budgets needs to be justified which are over and above the last year’s budget. This budgeting technique is easy to prepare and implement. However traditional budgeting brings some amount of rigidity as budgets once prepared, cannot change.

To have a detailed understanding of the method and its advantages and disadvantages visit – Traditional Budgeting.

What is Activity Based Budgeting Method?

Activity based budgeting is a budgeting method where budget is prepared after considering the cost drivers. It does not take into account past year’s budget. This method does an in depth analysis of all the activities that incur the cost. The outcome of the research determines the allocation of resources to an activity. This budgeting method aligns the business activities with business goals. This helps in increasing the efficiency and profitability of business.

To have a detailed understanding of the method and its advantages and disadvantages visit – Activity Based Budgeting.

Choosing a Method of Budgeting

These budgeting methodologies are suitable for every kind of business, but you need to compare and meticulously choose which budgeting technique fits right for your organization. The decision to select a particular method depends on a lot of factors like size of business, operations of business, focus of business, competition in business, market situation, etc.

Like for example, zero based budgeting and activity based budgeting can be used in the businesses where there is stiff competition. Zero based budgeting justifies and gives explanation of each item of cost. Similarly, in activity based budgeting all the business functions are aligned with the business goals. This leads to elimination of all the wasteful activities, resulting in cost savings. So in order to cut the cost of production and surviving the competition, zero based budgeting and activity based budgeting are the best choices.

Incremental budgeting and traditional budgeting methods can be used where there is limited fluctuation in the market price, consumer demand, etc. Since these methods of budgeting consider taking previous year’s budget as base and doing only incremental changes like adjustment for inflation rate, consumer demand, market situation etc., these changes can be made in the market where the organization will not be much effected by the change in environment.

Same way, large scale organizations generally do not opt for zero based budgeting and activity based budgeting, because these methods are costly and consumes a lot of resources. Also here manager’s main focus is to prepare good budget and because of that core activities of the business gets ignored.

In a nut shell, there are different methods of preparing budgets and there is no best method which fits all. Choice of method depends upon the type of business requirements.

References:


Traditional Budgeting

Meaning of Traditional Budgeting Traditional budgeting is a method of preparation of the budget in which last year’s budget is taken as the base. Current year’s budget is prepared …

Activity Based Budgeting

Activity based budgeting is a budgeting method in which budgets are prepared using Activity Based Costing after considering the overhead costs. In simple words, activity based budgeting is management …

Variance Analysis

Variance Analysis deals with an analysis of deviations in the budgeted and actual financial performance of a company. The causes of difference between the actual outcome and the budgeted …