Types of budgets

Types of budgets

The budget is basically future estimates of revenue or cost. Budgets may be categorized into periodic budget, rolling budget, fixed budget, flexible budget, incremental budget, and zero based budget.

1.    Periodic budget

Periodic budget is prepared for a period for example for one year and does not change during the period. This budget technique is widely used by the government, once budget is prepared; it is rarely changed during the year.

2.    Rolling budget

 Rolling budget is also known as continuous budget and budget is updated after a specific period of time. The concept is that budget is updating after some period of time. The advantage of this method is that budget is regularly updated and new situation incorporated in the budget, however this type of budget has little budgetary controls.

3.     Fixed Budget

A fixed budget does not change with level of activity. For example a construction manager has prepared a fixed budget for the construction of a bridge and site manager require completing the construction work within this budget. The fixed budget has no answer in certain situation where the budget depends on the level of activity.

4.    Flexible budget

A flexible budget changes with level of activity.  i.e (number of unit produced). For example for 10,000 units the production cost was 18,000 and for 12,000 unit production cost was 20,000. This budget is more practical approach of budgeting because budget are prepared for operation and activities and this method give due consideration to level of activity.

5.    Incremental Budget

The incremental budget use the last year budget as base and the incorporate inflation and other factor in that budget in that and thus a new budget is prepared. Main Advantages of incremental budget simple and time saving. The main disadvantage of incremental budget is bias of manager responsible for operation budgets; budget may be prepared to achieve the desired results.

6.    Zero Based Budgets

Zero based budgets are prepared from the scratch and every objective is to be redefining and every expense is to be re justified. This concept try to eliminate the wrong projection and encourages to prepare the budget on facts and not merely the changing the number in excel sheet. The biggest limitation of Zero based budget is time consuming.

Stages of budget Preparation

Stages of budget Preparation

1.     Identification of key Factor

 First stage in budget preparation is to identify the key factor for budget. Identification of key factor depends on the nature of business, however, normally for majority of businesses sales is key factor. It is important to remember that key factor provides bases for budget preparation.

2.     Key Factor Budget

The second stage in budget preparation is to prepare the budget of key factor (sales budget). The key factor budget provides bases for other functional budgets. Therefore a great care must be exercised while preparing the key factor budget. If budgets of key factor are not accurately prepared the whole process of budget will be at stake.

3.     Functional Budgets

Third stage in budget preparation is to prepare functional budgets; the other functional budget will be prepared in logical sequence. The typical sequence would be budget for production, and then budget for inventories, labor.

4.     Review of Budget

Fourth stage in budget preparation is to submit to the budget approving authority for review. The budget is reviewed by the budget committee and budget is explained to budget committee. The committee may require the further explanation and May also recommends the changes in the proposed budgets

5.    Incorporate Changes

Fifth stage of budget preparation is to incorporate changes recommended by the review committee. The budget is amended in accordance with recommendation of the budget committee.

6.    Master Budget

In sixth stage of budget preparation, functional budgets are incorporated into master budget. The master budget is overall budget for whole organization. Master budget is final product and used for different purposes i.e. directing activities, controlling cost etc.

7.    Budget Approval

In this stage of budget preparation, budget is placed to board of director for approval. The key objective is explained to board of directors and board of director approves the budget in principal. The budget may be approved by board of director without any change or may approve the budget after some changes and amendments.

8.     Communicate the budget

In this stage of budget preparation, budget is communicated to the relevant manager for implementation. The manager has a formal approved document in their hands and this document provides a basic guideline for activities to be carried out and range of those activities especially in financial terms.

9.     Monitor the budget

The budget may be divided into shorter budget.  example monthly and quarterly budget. It is necessary to sub divide the budget for control purpose. The management keeps a close eye on periodical budget. The variance is calculated and required adjustment is made to achieve the overall objective.

Advantages of Budget

Advantages of Budget

1. Communicate the plans

The budgets may be a source of communication plans to the relevant manager. Because the budgets are formal documents of the organization and prepared in a formal and structure way. Therefore it is not possible for manager to ignore the budgets.

2. Budget Set Targets

Budget can set performance targets for the organization and budget can be used as source document to evaluate performance of the manager. The performance evolution is critical for the employees because usually it is linked with the reward announcement for the employee. Therefore budget can play important role for improving the performance of manager and employees.

3. Budget set Limits

When the budgets are formally approved then it becomes an authorized expenditure limits and any expenditure which does not fall under these limit require special approval. Furthermore any expenditure which is not mentioned in the budget will also go to management for approval. Therefore budget put an effective control over expenditure.

4. Set a Direction

Budget is basically linking different department in formal way. Budget is prepared in a structured way and it takes into account the every department and therefore budget set a direction of moving forward. The budget is a linkage between different departments. Each department can get an idea about other department direction and activities from the budget.

5. Budget is Medium Term

The budget is normally considered to be a medium term plan and it provides a linkage between short term and long term planning. The budget is normally prepared for one year keeping in view the long term objective of the organization. The budget gives a direction to short term plan for achieving the long term plan.