Approaches to budgeting

Approaches to budgeting:

A periodic budget shows the costs and revenues for one period of time, e.g. a year and is updated on a periodic basis, e.g. every 12 months. However, there are many different ways in which a budget might be prepared.

Rolling Budgets:

A rolling budget is a ‘budget continuously updated by adding a further accounting period (months or quarters) when the earliest accounting period has expired (CIMA Official Terminology). Rolling budgets are also called ‘continuous budgets’.

Incremental budgeting:

The traditional approach to budgeting is to take the previous year’s budget and to add on a percentage to allow for inflation and other cost increases. In addition there may be other adjustments for specific items such as an extra worker or extra machine.

• Fairly small changes are made to the current year’s budget. For example, adjustments might be made to allow for a planned increase or decline in sales volume, and for inflationary increases in sales prices and costs.

• A check is then made to ensure that the budget produced in this way meets the performance targets of the organisation. For example, the company might have a target of keeping the operating costs to sales ratio at less than, say, 60%.

In a static business environment, incremental budgets are little more than ‘last year’s budget plus a percentage amount for inflation’. 

Zero-based budgeting

Zero-based budgeting (ZBB) is a radical alternative to incremental budgeting. In ZBB, all activities and costs are budgeted from scratch (a zero base). For every activity, managers look at its cost and its purpose, and consider whether there are alternative ways of doing it. Non-essential activities and costs are identified and eliminated, by removing them from next year’s budget.

Adoption of ZBB

ZBB has been adopted more widely in the public sector than the private, although examples of organisations regularly adopting a full ZBB approach are rare. Full-scale ZBB is so resource-intensive that critics claim that its advantages are outweighed by its implementation costs. However, it is not necessary to apply ZBB to the whole of an organisation; benefits can be gained from its application to specific areas. For example, in the public sector, a decision could be made regarding the overall size of the childcare budget, and ZBB could be applied to allocate resources within that particular field; similarly, in a business organisation, ZBB could be applied to individual divisions on a rotational basis. This selective application ensures that a thorough reappraisal of activities is undertaken regularly, but not so regularly that the process itself is a major drain on organisational resources.

Notwithstanding these criticisms, the main plank of ZBB approach - the rejection of past budgets as a planning baseline - is being increasingly accepted.

ZBB is more outward looking and considers the environmental changes that the organisation is likely to face. Nonetheless, it is a complex, time-consuming and expensive task.

Activity-based budgeting

Whereas ZBB is based on budgets prepared by responsibility centre managers, ABB is based on budgeting for activities. In its simplest form, ABB is simply about using costs determined via ABC to prepare budgets for each activity.

ABB is useful when overheads are significant within a business, but it relies on the use of Activity Based Costing which may not be used by all organisations.

References:

Kaplan Publishing

Other Agencies