This post contains a detailed information on the types of budget we have, and also the benefits of budgeting.
To avoid some of the problems in a business, creating a budget is must for every business owners or organisation.
This article covers all the different types of budget we have in finance.
A budget is a simple tool, a financial plan which an administrator uses to plan profit for profits by anticipating the revenues and expenditure of funds.
By adopting budgetary procedure, management hopes to guide the operation of the organisation to a predetermined and a given level of profit on a certain volume of operations.
Without a budget, management could never be certain whether operations were going successfully.
Executives would not know if the goals of the firm were being met until the final accounting had been made for the fiscal period.
A carefully planned and realistic budget is like a road map. Financial success begins with creating a budget.
Different types of budget
The types of budgets we have are as follows;
1. Zero based Budget
The first types of budget is the zero based budgeting (ZBB) which is an alternative approach that is sometimes used particularly in government and not for profit sectors of the economy.
Under zero based budgeting, managers are required to justify all budgeted expenditures not just changes in the budget from the previous year.
The baseline is zero rather than year’s budget.
In traditional approach of budgeting, the manager start with last year’s budget and add to it (or subtract to it) according to needs.
This is an incremental approach to budgeting in which the previous year’s budget is taken for granted as a baseline.
Zero based budgeting approach requires considerable documentation.
In addition to all the schedules in the usual master budget, the manager must prepare a series of decision packages in which all the activities of the department are ranked according to their relative importance and cost of each activity is identified.
Under zero based budgeting (ZBB) the review is performed every year.
Critics of such type of budgeting charge that properly executed zero based budgeting is too time consuming and too costly to justify on an annual basis.
In addition, it is argued that annual reviews soon become mathematical and whole purpose of zero based budgeting is when lost.
Whether or not the a company should use annual reviews is a matter of judgment.
Types of budget.
A few organizations have adopted this type of budgeting as an answer to one problem posed by traditional budgeting procedures.
2. Rolling Budget
Another types of budget we have is the rolling budget, which is a budget that is continually updated to add a new budget period as the most budget period is completed.
A rolling budget calls for considerable more management attention than is the case when a company produces a one static budget.
Since some budgeting activities must now be repeated every month.
In addition, if a company uses participating budget to create it’s budgets on a rolling basis, then the total employee time used over the course of one year is substantial.
Consequently, it is better to adopt a learner approach to a rolling budget with fewer people involved in the process.
A rolling budget is also described as a continuous budgeting or a perpetual budget or a rolling horizon budget.
It is a forward looking budget.
It is constantly looking periods into the future.
Types of budget and examples.
Example of rolling budget.
If ABC company has adopted a 12 months planning horizon, and it’s initial budget is from January to December. After a month passes, the January period is complete.
So it now added a budget for the following January, so that it still has a 12 month planning horizon that now extends from February of the current year to January of the next year.
3. Flexible type of Budget
Next types of budget we have is the flexible budget.
One classification of budget divides them into two categories, and they are flexible and inflexible budgets.
In an flexible budget, once the figures are established, they are not varied.
Example. Once N2m has been allotted to advertising, that figure will not be altered.
In flexible budget, even though a figure has been established for a certain expenditure, it can be altered to meet challenging conditions.
One major disadvantage of flexible budget is that it tends to become a master rather than a servant.
Once certain allotment is designated for a purpose, the executive tends to regard it as saved, and will spend the funds regardless of the needs.
This defeat the purpose of the budget system.
There’s always some unexpected needs and it is impossible to foresee accurately everything for which money will be needed.
A budget system that prevents the manager from spending money where it is needed is a most dangerous tool because it can result into not doing the things that must be done and doing other things that are not so important but are budgeted.
The three major periods for which budgets are commonly created are yearly, semi-annually and quarterly.
Some firms prepare budgets for all the three periods, others prefer to operate on annual basis, thereby reducing the amount of paper work required.
Here in this country, banks are required by law to prepare budgets annually to cover January to December.
The length of the budget period is closely associated with it’s flexibility.
Firms that uses a three month period have a much more flexible system than those that use an annual budget.
4. Capital Budget
The fourth on the list types of budget is the capital budget.
It is the amount budgeted for the purchase of assets to improve production either in speed, quality or maintain or expand production.
This can range from either one machine or a whole additional plant.
5. Master types of Budget
The fifth on the different types of budget is the master budget which is a summary of company’s plan that sets specific targets for sales, production, distribution and financing activities.
It generally culminates in a cash budget, a budgeted income statement and a budgeted balance sheet.
In short, this budget represents a comprehensive expression of management plan for future and how these plans are to be accomplished.
It usually consists of number of separate but interdependent budgets.
6. Operating Budget
The last but not least types of budget is the iperating budget which is concerned with utilization of existing assets.
It contains forecast of production, sales, selling and administrative expenses.
Normally, it is one year duration and consists of several sub-budget, most important being the sale budget.
The operating budget focuses solely on operating and expenses.
Non operating income and expenses are budgeted separately.
These are the different types of budget we have, now let’s look at the benefits of budget to an organization or a firm.
Benefits of budgeting
The benefits of budgeting a firm or an organisation will derive include the followings;
1. Provides Control of Expense Revenue Ratio: In operating a business, an important goal is to maintain the desired relationship between expenditure and income.
The objective of a business is to buy revenues at a reasonable cost, and the budget shows what this cost should be.
2. Acts as a Coordinated Mechanism: Budgeting is the best way to plan, control and coordinate the activities of the various segments of an enterprise.
It is a coordinating tool that allows the financial executives to plan for the coming needs.
3. Provides a Standard of Performance: The budget serves only as a plan of action but also a standard of performance for the various departments.
Once the budget is established, the departments can begin organizing to realize the plan.
If the budget has been based on the sound analysis of potential markets and competition, the organization will be encouraged to realize its full potential.
Otherwise the department might not know what what they could or should be achieving in the course of running the business.
4. Serves as an Evaluation Tool: Any goal, once established becomes a tool for evaluation or performance.
If the organisation meets its goals, the management can consider the performance successful.
Otherwise unsuccessful and bad management is the downfall of a business.
Reasons some organisations do not use the types of budgets
There are some quite reasons why some firms and organisations refused to adopt the different types of budget.
They are as thus;
The first reason is that some organisations feels that the budget procedure takes more time than it worth.
They point out that a budget makes no money in itself, but it definitely costs money to create.
The second reason is that the problem of budgets is that they commit the firm to expenditures before the actual revenue develops.
Another is the Size of the organisation.
Some organization administrators think that their organization are too small to have any meaningful grouping of sales and costs.
They maintain that their operations are of such limited in nature that it is ridiculous for them to budget for any one activity such as advertising.
Some critics say that budgets lead to waste, because the various departments feel it is necessary to spend budgeted fund regardless of the need.
The criticism of waste is essentially a reflection of weakness caused by inflexibility in budgeting.
Waste in budgeting can also occur when funds are allotted to one budget and then allowed to be transferred to other at the whims and caprices of a department head.
Next is conservatism.
Critics of budgeting sometimes maintain that budgets almost inevitable tend to be ultra conservative, thereby preventing the organisation from reaching it’s full potential.
These critics claim that the people responsible for preparing a budget are influenced basically by the belief that they are going to be judged by the plan.
Therefore, almost inevitable they understate their departments capabilities so that the actual performance will make them appear in a favourable light.
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