Budgeting

What is Budget?
A budget is a quantitative plan for acquiring and using resources over a specified time
period. Individuals sometimes create household budgets that balance their income and
expenditures for food, clothing, housing, and so on while providing for some savings.
Once the budget is established, actual spending is compared to the budget to make sure
the plan is being followed.
Budgets are used for two distinct purposes—planning and control.

Planning involves developing goals and preparing various budgets to achieve those
goals.
Control involves the steps taken by management to increase the likelihood that all
parts of the organization are working together to achieve the goals set down at the
planning stage.
To be effective, a good budgeting system must provide for both planning and control.
Good planning without effective control is a waste of time and effort.
Advantages of Budgeting
Organizations realize many benefits from budgeting including:

1. Budgets communicate management’s plans throughout the organization.

2. Budgets force managers to think about and plan for the future. In the absence of the necessity to
prepare a budget, many managers would spend all of their time dealing with day-to-day
emergencies.
3. The budgeting process provides a means of allocating resources to those parts of the organization
where they can be used most effectively.
4. The budgeting process can uncover potential bottlenecks before they occur.
5. Budgets coordinate the activities of the entire organization by integrating the plans of its various
parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction.
6. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent
performance.
The Self-Imposed Budget

The success of a budget program is largely determined by the way a budget is developed.
Oftentimes, the budget is imposed from above, with little participation by lower-level
managers. However, in the most successful budget programs, managers actively participate
in preparing their own budgets. Imposing expectations from above and then penalizing
employees who do not meet those expectations will generate resentment rather than
cooperation and commitment. In fact, many managers believe that being empowered to
create their own self-imposed budgets is the most effective method of budget preparation.
Self-imposed budgets have a number of advantages:

1. Individuals at all levels of the organization are recognized as members of the team
whose views and judgments are valued by top management.
2. Budget estimates prepared by front-line managers are often more accurate and
reliable than estimates prepared by top managers who have less intimate knowledge
of markets and day-to-day operations.
3. Motivation is generally higher when individuals participate in setting their own
goals than when the goals are imposed from above. Self-imposed budgets create
commitment.
4. A manager who is not able to meet a budget that has been imposed from above can
always say that the budget was unrealistic and impossible to meet. With a self-
imposed budget, this excuse is not available.
The Master Budget: An Overview
The Sales Budget
The Production Budget
Characteristics of a Flexible Budget

The budgets that we explored in the last chapter were planning budgets. A planning budget is prepared before
the period begins and is valid for only the planned level of activity. A static planning budget is suitable for
planning but is inappropriate for evaluating how well costs are controlled. If the actual level of activity differs
from what was planned, it would be misleading to compare actual costs to the static, unchanged planning
budget. If activity is higher than expected, variable costs should be higher than expected; and if activity is lower
than expected, variable costs should be lower than expected.
Flexible budgets take into account how changes in activity affect costs. A flexible budget is an estimate of what
revenues and costs should have been, given the actual level of activity for the period. When a flexible budget is
used in performance evaluation, actual costs are compared to what the costs should have been for the actual
level of activity during the period rather than to the static planning budget. This is a very important distinction.
If adjustments for the level of activity are not made, it is very difficult to interpret discrepancies between
budgeted and actual costs.
Zero-Based Budgeting

ZBB is a budgeting process that allocates funding based on program efficiency and
necessity rather than budget history.
Zero Base Budgeting is a method of budgeting in which all expenses must be justified
for each new period. Zero base budgeting starts from a ‘Zero-base’ and every function
within an organization is analyzed for its needs and costs. Budgets are then built around
what is needed for the upcoming period, regardless of whether the budget is higher or
lower than the previous one.
ZBB is a technique which complements and links the existing planning, budgeting and
review processes. It identifies alternative and efficient methods of utilizing limited
resources in the effective attainment of selected benefits.
 The Objective of Zero Based Budgeting is to “reset the clock” each year.
 The Traditional incremental budgeting assumes that there is a guaranteed budgetary base-the
previous year’.
 Zero Based Budgeting implies that managers need to build a budget from the ground up, starting
at zero.
 Resources are not necessarily allocated in accordance with previous patterns and consequently
each existing item of expenditure has to be annually rejustified.
 Purpose - ZBB is to reevaluate and reexamine all programs and expenditures for each budgeting
cycle by analyzing workload and efficiency measures to determine priorities or alternative levels of
funding for each program or expenditure.
 Through this system, each program is justified in its entirety each time a new budget is developed.
Advantages
• Resulting budget is well justified and aligned to strategy
• Catalyzes broader collaboration across the organization
• Supports cost reduction by avoiding automatic budget increases, often resulting in savings
• Improves operational efficiency by rigorous challenging of assumptions

Disadvantages
• Costly, complex, and time consuming as budget is rebuilt from scratch annually, whereas
simpler and faster traditional budgeting requires justification only for incremental changes
• May be cost-prohibitive for organizations with limited funding
• Risky when potential savings are uncertain
• Execution challenged by budget cycle timing constraints
• Typically requires specialized training or personnel to accomplish, and requires more resources
in general
• May be disruptive to the organization’s operations
• Could harm organizational culture or brand