A budget is basically a plan of action for the forthcoming business period and budget planning should involve the whole organisation. The ability to budget effectively is crucial both in terms of performance and profitability as without having an awareness of costs it is all too easy to spiral down into losses over a period of time.
There are thee main budgeting techniques:
- Incremental budgeting
- Zero-based budgeting
- Flexed budgeting
What is Incremental Budgeting?
The incremental approach to budgeting combines the costs identified from the previous accounting period with percentage additions. These percentage additions are utilised to cover two key areas which include cost increases as a result of inflation or higher purchases costs and predictions associated with increases in costs and income as a result of business volume predictions.
A key limitation of the incremental budgeting system is the manner in which percentages are added in a blanket fashion resulting in the likelihood of higher overall costs in the long-term. This may then also result in a business having to increase its sale prices to a level that is no longer competitive.
What is Zero-Based Budgeting?
The clue is is in the title here as the zero-based budgeting system requires budgeting to commence with the assumption that every cost has a zero base. Next, each item relating to expenditure is worked through and decisions are made as to whether the purchase is completely essential. Then different purchasing options associated with the specific item are explored as a means of ensuring the item is obtained as cost-effectively as possible.
One of the main limitations of the zero-budgeting system is that it can take an awful lot of time to work through each individual cost in this manner. However, it is fair to add that utilising this approach will then provide an extremely useful database containing valuable, time-saving information for the years to come.
What is Flexed Budgeting?
As with zero-based budgeting, the flexed budgeting system gives its name away in the title as it involves ‘flexing’ the normal budget. The benefits of flexed budgeting are that it is likely to be considerably more accurate as the budget is adapted to suit various external changes. Within this approach managers are able to provide key information resulting in an achievable budget, pessimistic budget and optimistic budget.
Through undertaking the process of flexed budgeting, managers are better able to make important decision relating to risk and expenditure, having gained a wider perspective on best and worst outcomes.
As highlighted above, there are three main categories associated with budgeting which include incremental, zero-based and flexed budgeting. Each of these approaches has various strengths and limitations with the latter approach being able to provide more accurate information.
Brown, B. (2009) Successful Finance Surrey: Crimson