STRATEGIC PERFORMANCE

MANAGEMENT
APPROACHES TO BUDGETS

Usama Jiffry, CFA

APPROACHES TO BUDGETS | Purpose of Budgeting
• Budget: is a quantitative plan prepared for a specific time period. It is normally expressed in financial terms and

prepared for one year.

• Serves a number of purposes:

• Planning

• Control

• Communication

• Co-ordinate

• Evaluate

• Motivate

• Delegate

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APPROACHES TO BUDGETS | Participating in Budget Setting
• Top-down (non-participative): Imposed on the budget holder by the top management.

• Bottom-up (Participative budget): Divisional managers participate in the budget setting process.

It is also possible to have a mix of the

process, which would be up to the
management to decide the extent to which
it takes place

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible
Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible • Fixed budget: Prepared at a single level of activity. Static budget based on a single
Budgets predicted amount of sales or other activity.
• Flexible budget: prepared with the cost behaviour of all cost elements known and
Incremental Budgets classified as either fixed or variable. The budget may be prepared at a number of
activity levels and can be 'flexed' or changed to the actual level of activity for
budgetary control purposes. E.g.; Based on several different amounts of sales. c
Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Illustration:

Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Illustration:

Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible
Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Starts with the previous period's budget or actual results, and adds (or subtracts) an
Budgets incremental amount to cover inflation and other known changes.

Suitability:
Incremental Budgets
- For stable businesses where no significant cost changes are forecast
- There should be a good cost control
Zero Based Budgets - There should be limited discretionary costs

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Illustration:

Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Illustration:

Budgets
20X4 Last year units
A 640
C 350
Incremental Budgets
Total costs 672,000

Variable costs (75%) 504,000 Fixed costs 168,000

Zero Based Budgets
Per unit cost
Variable costs A (60%) 302,400 472.50
Variable costs B (40%) 201,600 576.00
Rolling Budgets
20X5
Variable cost for C inflated @ 4% 4% 599.04
Number of units 340
Activity based Budgets
Total variable cost for C 203,673.60

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Method of budgeting that requires each cost element to be specifically justified, as
Budgets
though the activities to which the budget relates were being undertaken for the first
time. Without approval, the budget allowance is zero.
Incremental Budgets Suitability:
- Fast moving businesses/industries.
- Discretionary costs such as research and development (R&D).
Zero Based Budgets
- Public sector organisations such as local authorities.
Process
Rolling Budgets 1. Managers should specify for their responsibility centres those activities that can be
individually evaluated.
2. Each of the individual activities is then described in a decision package. The decision
Activity based Budgets
package should state the costs and revenues expected from the given activity. It
should be drawn up in such a way that the package can be evaluated and ranked
against other packages.
3. Each decision package is evaluated and ranked usually using cost/benefit analysis.
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4. The resources are then allocated to the various packages.
APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Decision package: defined by Peter Pyhrr (who first formulated the ZBB approach at
Budgets
Texas Instruments) as; Document identifying and describing a specific activity in such a
manner that management can decide weather to go ahead or not approving it. It
Incremental Budgets includes;
- Analyses the cost of an activity
- Purpose of the activity
Zero Based Budgets
- Alternative methods of achieving same purpose
- Consequence of not undertaking the activity at all
Rolling Budgets - Performance measures attributable

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible
Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Budget which is kept continuously up to date by adding another accounting period (e.g.
Budgets
month or quarter) when the earliest accounting period has expired.
Suitability
Incremental Budgets - When accurate forecast are difficult (dynamic industry)
- For any businesses that needs tight control

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Illustration:

Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Illustration:

Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Review activity based models (general):

Budgets
ABC - Activity Based Costing:
The aim of ABC is to calculate the full production cost per unit. It is an alternative to
Incremental Budgets
absorption costing in a modern business environment.
Steps in ABC
Zero Based Budgets - Group prod. OH into activities (cost pools) according to how they are driven
- Identify cost drivers of each activity (what is the cause of the costs)
- Calculate an Overhead Absorption Rate (OAR) for each activity
Rolling Budgets
- Absorb the activity cost into the product
- Calculate the full production cost/profit or loss
Activity based Budgets - For any businesses that needs tight control

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APPROACHES TO BUDGETS | Methods of Budgeting
Sample question ABC
Fixed / Flexible
Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting
Sample question ABC - Answer
Fixed / Flexible
Working 1
Budgets
Type of overheads
Set ups 35% 229,075
Machining 20% 130,900
Incremental Budgets Materials handling 15% 98,175
INspection 30% 196,350
100% 654,500

Step 1 / 2
Zero Based Budgets
Overhead activity Cost driver for each activity
Set ups Number of set ups
Machining Number of machining hours
Rolling Budgets Materials handling Number of movements of materials
Inspection Number of inspections

Step 3
Calculate OAR for each activity
Activity based Budgets
Activity cost
Set ups = 229,075
Machining = 130,900
Materials handling = 98,175
Inspection = 196,350
Cost driver
670 set ups
23,375 machine hours
120 material movements
1,000 inspections
OAR = activity cost / cost driver
229,075/670 341.9029851 per set up
130,900/23,375 5.6 per machine hour
98,175/23,375 818.125 per movement of material
196,350/1,000 196.35 per inspection
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APPROACHES TO BUDGETS | Methods of Budgeting
Sample question ABC - Answer
Fixed / Flexible
Budgets Step 4
Absorb activity cost into products
Numbet of set ups Material movem Inspections Machining
Product X 75 12 150 1.5
Incremental Budgets
Product Y 115 21 180 1
Product Z 480 87 670 3
670 120 1000
Zero Based Budgets
Product X Product Y Product Z Total
Set ups 25,642.72 39,318.84 164,113.43 229,075.00
Machining 6,300.00 7,000.00 117,600.00 130,900.00
Rolling Budgets
Materials handling 9,817.50 17,180.63 71,176.88 98,175.00
Inspections 29452.5 35343 131554.5 196,350.00
Total production overhead 71,212.70 98,842.50 484,444.80 654,500.00
Activity based Budgets Production OH per unit 94.95 79.07 69.21

Machining
Number of units Machine hrs @ $ 5.6/hr
Product X 750 1.5 6,300.00
Product Y 1,250 1 7,000.00
Product Z 7,000 3 117,600.00 80
APPROACHES TO BUDGETS | Methods of Budgeting
Sample question ABC - Answer
Fixed / Flexible
Budgets Step 5
Calculate full production cost per unit
Product X Product Y Product Z
Incremental Budgets Direct costs 23 21 31
Prodcution overheads 94.95 79.07 69.21
Full production cost under ABC 117.95 100.07 100.21
Zero Based Budgets
Full production cost under absorption costing 64 49 115

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible
Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible ABM - Activity Based Management:

Budgets
the use of ABC information for management purposes to improve operational and
strategic decisions. Performance should improve as a result.
Incremental Budgets
- By identifying the underlying drivers of activities, ABM provides an understanding of
the resource implications of various courses of action and therefore ensures that
Zero Based Budgets unfeasible courses of action are not taken.
- Assists in re-pricing or eliminating unprofitable products
- May eliminate activities that are non value adding
Rolling Budgets
- Identifying ways to produce product more efficiently
- Helps with design improvement

Activity based Budgets - Can decide which products to develop and which strategies to pursue
ABM can help managers to make decisions that benefit the whole organisation, not just
their activities' bottom line and ensure that the needs of the customer are being met.

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APPROACHES TO BUDGETS | Methods of Budgeting
Types of activity based management

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APPROACHES TO BUDGETS | Methods of Budgeting
Illustration: Operational ABM

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APPROACHES TO BUDGETS | Methods of Budgeting
Case study: Application of ABM at DHL

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible Activity Based Budgeting:

Budgets
uses the principles of ABC to estimate the firm's future demand for resources and hence
can help the firm to acquire these resources more efficiently.
Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting

Fixed / Flexible
Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting
Illustration: ABM
Fixed / Flexible
Budgets

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Methods of Budgeting
Illustration: ABM
Fixed / Flexible
Budgets Solution

Incremental Budgets

Zero Based Budgets

Rolling Budgets

Activity based Budgets

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APPROACHES TO BUDGETS | Variances
Variance analysis was a key element of management control:
1. Targets and standards are set reflecting what should happen.
2. Actual performance is then measured.
3. Actual results are then compared with the (flexed) standards, using variance analysis.
4. "Significant" variances can then be investigated and appropriate action taken.

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APPROACHES TO BUDGETS | Variances
Different types of budget variances

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APPROACHES TO BUDGETS | Variances
Different types of budget variances

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