APPROACHES TO BUDGETING

BUDGET
A budget is a systematic method
of allocating financial, physical
and human resources to achieve
strategic goals. It is an
organisational plan, stated in
monetary terms for the utilisation
of manpower and material
resources and covers a specific
period of time.
Budgets are really stories about what
is being done in the business.
Companies develop budgets in order
to monitor progress towards their
goals, help control spending and
predict cash flow and profit.
The actual results are compared with
the budgeted figures and the
variances between the two are
analysed.
TYPES OF BUDGETS
Fixed budget
A fixed budget is a master budget
that is devised based on capacity
level to be achieved during the
budget period. Organisational
planning is achieved by means of a
master budget. A master budget is a
statement showing the estimation of
revenue, costs and profit (loss) for
the organisation as a whole..
It displays a consolidation of the
functional budgets to present the
overall impact of the projected
operational activities on the profitability
of the organisation as a whole.
 It resembles the financial statements
(i.e. the income statement and the
balance sheet).
financial statements uses historical data
while master budget deals with
expected future data
Flexible budget
A flexible budget is designed to adjust the
cost levels according to changes in the
actual level of activity.
Flexible budgets are mainly used to
exercise control over the business
activities.
They are more elastic, more useful and
more practical.
A flexible budget presents a budgeted
amount for each item of revenue and
expense against the various levels of
activity
A flexible budget recognises different
cost behaviour patterns i.e. analyses
costs into their fixed, variable and
semi-variable components in order to
estimate costs for different activity
levels.
 A flexible budget is designed to
change as the volume of output
changes i.e. different sets of
estimates of costs are prepared for
different activity levels.
Rolling budget
 Itis a budget that needs to be continuously
updated by deducting the earliest period and
taking into consideration the future period.
 This approach to budgeting helps to
eliminate the adverse impact of
environmental uncertainties on setting goals
by updating the budget in quick succession
and hence encourages a forward-looking
attitude.
 They are prepared on the basis of recent
experience by taking into consideration the
current period, and updated with the current
changes thus contain current information.
This helps to minimise the
operational variances and are
suitable in organisations working in
an uncertain environment, where
future costs and/or activities cannot
be foreseen reliably.
Activity-based budget
(ABB)
This is an approach to budgeting in
which, activities causing costs are
evaluated in order to ascertain whether
they are essential for the budgeted
production and sales volume.
 It aims to ensure the supply of only
those resources that are needed to
perform activities required to meet the
budgeted production and sales.
 Like all other approaches to budgeting,
it is also a feedback activity.
Activity-based costing assigns
resource costs to activities and then
uses activity cost drivers to assign
activity costs to cost objects (such as
products, services or customers).
 Cost objects are the starting point.
Their budgeted output determines
the necessary activities which are
then used to estimate the resources
that are required for the budget
period.
Zero base budget
is an elaborate practice in which
managers justify activities from scratch,
as if they were being launched for the
first time.
 It is therefore a method of budgeting
which needs each cost element to be
specifically justified, as though the
activities to which the budget relates
were being undertaken for the first time.
Without approval, the budget allowance
is zero.
Each year when the budget is
prepared, all the cost elements have
to be evaluated as if the budget were
being undertaken for the first time
and will be authorised only if the cost
elements are justified.
The justification of any cost should
take into account how the
expenditure helps the organisation to
meet its objectives i.e. how it
benefits the organisation.
It can also be described as a cost or a
budget centre.
Therefore the manager becomes
responsible for each cost centre in the
organisation.
Pros
It helps in deciding the most suitable
way of performing an activity.
it creates a questioning attitude within
the organisation which helps in
curtailing the activities which do not
provide best value for money
Incremental budgets
isa way of preparing budgets, in
which budgets are prepared on the
basis of the previous year’s budget
with some additions and deletions
for the forthcoming budget period.
Cons
Fails to cope with a fast-changing
environment and hence are often
out-of-date before the start of the
budget period
Failsto cope with a fast-changing
environment and hence are often
out-of-date before the start of the
budget period.
Encourage incremental thinking by
employing a ‘last year figure plus a
certain per cent’ approach to
planning and can inhibit the
development of ‘break out’
strategies that may be necessary in
a fast changing environment.
Budgeting in Not-for-profit
organisations
These include organisations of
many different forms, for
example
Schools and universities, social
clubs, sports clubs, sports
governing bodies, hospitals,
museum/ library/arts
organisations, government
organisations/local authorities
Things to remember
No profit motive, but they still need to
control costs.
•Many of the benefits arising from
expenditure by these bodies are non
quantifiable (certainly not in monetary
terms, e.g. social welfare).
So how can measurable budgets be prepared
which meet the organisation’s objectives?
•Often revenue is not generated and there is
a fixed budget for spending within which
they have to keep (i.e. a capital rationing
problem). ‘’
Value for money’ is often quoted as an
objective here but it does not get round the
problem of measuring ‘value.
Multiple stakeholders give rise to multiple
objectives so there is a need to
prioritise/compromise (e.g. hospital
patients, staff, government, taxpayers,
local community, society at large,
contractors, management,
donors/contributors, etc.).
 Objectives may be difficult to define, may
change as a result of the political process
and may be achievable in different ways
Beyond budgeting’ model
The new model promotes a more
decentralised, participative approach to
managing the business.
 This traditional structure is replaced by a
network structure where decision-making is
devolved to front-line managers.
In the new structure, a more open,
questioning attitude among employees is
encouraged.
There is a sharing of knowledge and best
practice, and protective behaviour by
managers is discouraged
In addition, rewards are linked to
targets based on improvement in
relative performance rather than to
meeting the budget.
It is claimed that this new approach
allows greater adaptability to
changing conditions and increases
performance and motivation among
staff.
Beyond budgeting is about releasing
capable people from the chains of the
top-down performance contract and
enabling them to use the knowledge
resources of the organisation to
satisfy customers and consistently
beat the competition.
 With intellectual assets accounting
for 80-90% of shareholder value today
(particularly in the knowledge-based
industry), people really are the
organisation’s most valuable asset.
in today’s highly competitive
environment a business must be
flexible and responsive to changing
conditions.
 Management systems that in any
way hinder these attributes will not
survive.
Application of beyond budgeting
in private sector organisations
Private sector managers need to
consider environmental issues that
might affect business performance.
Accordingly, private sector managers
depend on rolling monthly forecasts of
financial performance with an emphasis
on non-financial 'value drivers'.
 The 'beyond budgeting' model requires
devolved managerial responsibility
where power and responsibility are
vested in the same group of managers.
It creates and promotes a performance
climate with the aim of competitive
success.
It motivates managers by giving those
challenges and responsibilities and
identifying values as guidelines.
It delegates performance responsibilities
to operational management which
converts the plans into action.
It authorises managers at operational
level to perform by providing them with
sufficient resources
The ‘Beyond budgeting’ model –
as applicable to public sector
 The introduction of the beyond budgeting
model in public sector organisations is
difficult because of their rigid, legal
framework.
 To be successfully implemented in an
organisation, the beyond budgeting model
focuses on organisational, managerial and
cultural changes in the organisation.
 Accordingly, considerable behavioural
challenges take place in the organisation and
individual managers might become perplexed
by the complexity of decision-making in the
unregulated decision-making environment.
In the public sector, the budget
process has an overwhelming
influence on organisational
processes, and the budget
represents the financial expression of
policies resulting from politically
motivated goals and objectives.
 However, many managers in the
public sector also need to work under
tremendous pressure caused by a
resource-constrained environment
and growing competition.
 In essence, a public sector budget sets
out the expected level of income and
expenditure and normally has the
following features:
 authorises expenditure out of the
expected income.
 acts as a control on expenditure
and income
 communicates operating policies
and plans of the organisation looks at
the future
 motivates managers and staff
For example, many public sector units are
not allowed by their governing laws to
finance budget deficit by borrowing.
 The implementation of the beyond
budgeting model will necessitate greater
freedom for managers to take their
business decisions.
It can be ensured by a considerable
change in mind-set in the public sector
(particularly with respect to bringing in
flexibility in operation, introducing more
delegation to the managers, etc.).
However, there are possibilities of
behavioural issues arising.
Local authority financial regulations
also may restrict the transfer of
funds from one budget head to
another (otherwise known as
virement) without compliance with
various rules and regulations.
Discussion questions
‘These rules (expressed in the
financial regulations of public sector
organisations) will be consistent with
the policies of the organisation and
are designed to prevent expenditure
on items such as permanent staff
where such costs would go beyond
the budget year and represent a
commitment of future resources’.