Introduction
Budgeting is defined as the plan to prepare a budget that shows the financial receipts and expenditure for a period. It will also be used as a means through which future cash flows could be anticipated and as a means through which the resources can be controlled. In other words, it involves planning the budget, executing it and finally controlling it. Thus, there is such a thing as budgeting budget.
There are five major classifications of budgets, such as:
- According to User – Namely the Corporate Budget [business budget], and the Personal Budget [individual budget].
- On the basis of Time – A budget prepared for a specific time period which is also known as Budgeting Time (Short term budget, mid-term budget long term budget).
- Flexible Budget – A budget prepared with reference to the capacity i.e., the Static Budget and a Flexible Budget.
- According to Wider classification – A budget based on the broader area or focus which is covered in the budget such as Functional Budget and the Master Budget.
- According to Receipts and Expenditures – A budget that involve all the revenues and any expenditure for instance the Capital Expenditures Budget and Revenue Budget.
Types of Budgeting According to Classifications
There are two main different types of budgeting according to user, one for corporate users. Though in essence, both functions the same when it comes to tracking the financials and allocating resources, a corporate budget is much more comprehensive which requires different types of budgeting compiled and structured in a logical system.
1. Master budget
A master budget is the total budget of the different special budgets that exist in a business and the operating plan for a specified future period.
It is normally prepared on an annual basis or at times on a per quarter basis. In principle, it is compendium of sub-budgets combined to present the anticipated actions of the firm. Or in layman language, the official declaration of the management’s forecast on the volume of sales, expenses and other transactions that are likely to occur in the business during the period following the preparation of this report.
A master budget is a collection of several budgets combined together into one flow. As an example, below illustration shows a comprehensive master budget of a manufacturing company.
2. Operating Budget
The operating budget is designed as a presentation of operating decisions, mainly focusing on expenses on goods or services which are offered. One lives in the income statement and it is crucial to view the health of the business.
The operating budget consists of several types of budgets such as:
Sales Budget – A component of the master budget as the estimated sales volume is the base for nearly all elements also located in the master budget. It should indicate the overall physical or actual amount of the products sold for example break-even, projection sales volume. The sales budget also involves computing the expected cash collection from credit sales which the cash budget will use in future.
Production Budget – This is only determined right after the sales are budgeted. The production budget is an outcome by product and is often stated in quantities. It consider the sales budget to a very large extent and also the plant capacity. In its simplest form, the expected number of units is outlined in the production budget in order to meet the set budgeted sales and inventory.
This can be computed as follows: Expected Production Volume =Targeted selling + Targeted inventory at the end of the period – Initial stock.
Merchandise Purchase Budget – (for merchandising, retailing or wholesalers) This type of budget is prepared instead of a production budget which is mostly provided for a manufacturing concern. The merchandise purchase budget is similar to the product purchase except it displays the quantity of products require from its suppliers in the period. In other words, it reveals the goods to be consumed than the goods to be created.
This can be computed as follows: Purchases that must be made = Estimated of Cost of Sales + Desired inventory at the end of the year – Merchandise inventory at the start of the year.
Direct Materials Budget – This type of budget is prepared immediately after arriving at production budget showing how much material will be required for production or in other words one is meant to indicate materials which have to be bought to meet production requirement. It is usually followed by an expected cash payment computation for materials if any.
This is best computed as follows: Purchases in units = Usage + Ending material inventory units desired – Beginning material units’ inventory.
Direct Labor Budget – Before putting forward this kind of budget, a construction of a production budget is essential. However, this can be computed together with the direct material budget and also the factory overhead budget. Cognate, the direct labor budget is calculated by an interaction of the utilization volume per period and direct labor hours that must be incorporated per product. Production requirements in terms of direct labor hours are then multiplied by the (standard) direct labor rate per hour to arrive at the budgeted total of direct labour cost.
3. Financial Budget
In terms of the financial budget, the budget seeks to present the financial action plan of the business, which mainly forecasts the business’s assets, liabilities, and stockholder’s equity. and the cash budget, budgeted balance sheet and is another important tool to view the business’s financial health.
Cash Budget – The cash budget provides the forecasted inflow and outflow for a certain period. It assists in taking and outlining cash balances that are well deployed depending on the necessary operations for the business it also assists in controlling on unnecessary or idle cash and on the other extreme a shortage of cash.
It has 4 major sections:
- Receipts beginning cash balance and all monies received from customers and other sources.
- Expenditures – all cash expenses and all funds which have been [spent out] for any purpose.
- Income or Expenditure – it is the residual of total cash received with total cash expended
- Financial planning – clear report on the loans and loan recovery anticipated to be made during the period
Budgeted balance sheet- This is a summary report of the company displaying the having budgeted assets, liabilities as well as the budgets for the equities for the accounting period in question and they are like budgeted income statements in that, instead of summarizing the sales and expenses they summaries budgets of the company. In other words, the budgeted balance includes all the accounts derived from a number of supporting calculations as to verify if the identified cash flow, which is expected to be expected, for the funds required by the business for financing during the budgeting period is sufficient. Preparing this type of budget is often done in the last stages of working on developing a master budget.
The reasons as to why the budgeted balance sheet is important are the following:
- To reveal some aspects of financial situation that management would not wish to occur
- For a final verification of the accuracy of all other budgets
- For the different ratio calculations to be made by the management
- To draw attention to the policy’s future foreseen sources and responsibilities
4. Static (fixed) Budget
Static Budget or known as Fixed budget – This kind of budget presents the budgeted amounts as per the fixed capacity level. It is the amount of secured fixed fund provided for the particular purpose. In other words, it is not variable and is fixed at the time of the preparation of the budget and does not change throughout the entire lifetime of the budget even if conditions change in the course of the stabilization period of the budget.
5. Flexible (expense) Budget
An example of a flexible budget or the Expense budget is presented in the following specific format: a variable relation to specific factors such as sales, production or other external economic influencing factors in business. Consequently, there is a lot of preference for creating a flexible budget because of the ability to portray variability within the business and for such changes. It is not a static approach, which contrasts with the other approach entirely.
6. Capital Expenditure Budget
Capital Expenditure Budget is a budget of all major permanent projects to be done and capitals required. Often classifies individual projects by objective such as:
The increase and improvement of existing product portfolios
Reduction in the cost of an item and replacement
Development of new products
Evaluating total expenses spent on Health and SafetyNet.
7. Program Budget
The program budget is another general budget in which you allocate the funds to programs and you cannot use them for controlling since there are costs which are shown that cannot normally be associated with particular individuals.
8. Incremental Budget
In its broadest sense, the incremental budget is a type of budget that displays the amount of the increase in the budget in dollar terms or as a percentage: without reference to the accretion body of the budget is tracked by this kind of budget. In a nutshell, it is made from a previous budget as the base for the extra sum to include in the new budget which in return fosters the capacity of a project to hold to the budget.
9. Add-on Budget
The add on budget takes prospective of the past budgets and estimate them as per the present records like inflation and raises to the employees. This type of budget is just as the name suggests, is an additional budget in the event that there will be new needs to be met.
10. Supplemental Budget
This is a budget that you prepare for extra funding for an activity that you did not provide for under the normal budget plan. In other words, retain a part for augmenting for some items which require funding.
11. Bracket Budget
A Bracket budget is also referred to as the contingency plan in which costs are assumed to be higher or lower than the base cost. This kind of budget allows the management to gauge the earnings influence and a backup expenditure plan in case of failure to realize the following base budget and the forecasted sales. That is suitable where there is a high risk of loss such as a sharp decline in sales.
12. Stretch Budget
The stretch budget is actually, another form of the contingency budget, but it is more commonly associated with the optimistic side only. In other words, it only differs from estimates in certain sales and marketing forecasts that are above expectations. It can hardly be applied to expenses. Where it can be considered as official estimates for sales and marketing personnel, the targets for the stretch budget are usually held informally and without making operating units accountable for them. But as for the expenses, most often it is calculated by standard budget only.
Differences between Traditional Budgeting and Zero-Base Budgeting
Traditional Budgeting – technique widely used by many for a long time and this method consists of adding or subtracting given percentage juts enhance on the previous period’s budget to derive a new one. It deals more with inputs than with outputs concerning the attainment of goals hence the value intensification requiring evaluation for each activity from the perspective of cost or benefit is not necessary.
- Refers to an existing data / base
- Discussed on the rational of cost borne and efficiency gained for new activities
- Starts with dollars
- Omitting the consideration of new forms of work as a component of that process
- The report that comes out is the non- • It is a partisan budget alternative to the president’s proposed budget and crafted by the majority party in the House of Representatives.
Zero Base Budgeting – the method employed where all costs must be financed from the newly DAO’d amount. Fundamentally, it entails preparation of a budget whenever from the utilization of a new appraisal of a given entry.
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- Starts with zero base
- Not only evaluates the cost and benefits of new activities but all the activities and enterprises.
- From purposes to activities
- Focuses on the new processes where they are mentioned in an unambiguously manner
- The outcome of the report is well sectioned, which presents the option of several levels of service and cost.
It is widely recognized that zero base budget is most useful when planning service and support costs, marketing, research, engineering, manufacturing support, capital cost, etc. However, this type of budget is only suitable for operations and programs with managements that have some nod of control, in other words, it is not applied on direct labour, direct material and factory overhead.
FAQ’s
What is the standard procedure when it comes to budgeting in organisations?
Step 1: Set goals and objectives.
Step 2: Collect by the historical data and the financial information.
Step 3: Distinguish between the fixed cost and variable cost.
Step 4: Individual budgets should be created and strengthened.
Step 5: Revisit the budget, approve and disseminate the budget.
Step 6: This is where one should be tracking and overseeing the levels of performance and plan to change them.
Describe the role of budgeting in an organization and who does it?
Budgeting normally takes place in association with those in the organizational sub unit level headed by department heads as well as the organizational center headed by finance personnel and top managers. It is normally coordinated by the finance department in the organisation.
To what extent is budgeting relevant to organisations?
- It helps in defining exactly how to get there from where you are to where you want to be with regard to finances.
- Balances resources in order to maximize their optimum use.
- Used in the monitoring and control of performance and also used in risk management.
- Helps in decision making process and strategic development.
In what ways can accounting help increase accountability?
It also plays a critical role of establishing specific tangible financial goals and goals and defining who has to be held accountable for meeting those goals at every organizational stage.
What do people get wrong when it comes to budgeting in their organizations?
Unrealistic Assumptions: Unrealistic targets or time horizons Following unfair or unhelpful polemics Unsupportive or unrealistic tests.
Time Constraints: Another disadvantage of budgeting is that it will take time.
Resistance to Change: Subordinate may resist change to new techniques of controlling expenditure such as the zero- based-budgeting
External Factors: There is always a very thin line between spending and saving, sometimes due to volatile levels of economic activity and other such factors, even organizational budgets are not safe.
What measures can organizations take in order to reduce budget constraints?
- Timely and accurate information must be used.
- Adopt the use of the flexible budget.
- Spend in good budgeting software so that this activity can be done effectively.
- Engage everybody because then you get their commitment and buy-in.
Do you know how an operating budget looks like?
An operating budget for a retail company might contain sales, cost of sales, and the anticipated amounts for wages, costs of occupancy, utilities, promotion, and other expenses.
Capital budget: What is an example?
A manufacturing company’s capital budget may contain the proposition to acquire new equipment, construction of a new plant or acquiring sophisticated technology.