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BUDGETING TECHNIQUES

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The three main budgeting techniques and their advantages and disadvantages.
(Zero-based budgeting is not elaborated)

Published in: Business
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BUDGETING TECHNIQUES

  1. 1. ALLPPT.com _ Free PowerPoint Templates, Diagrams and Charts BUDGETING
  2. 2. What is Budgeting? What is a Budget? Budgeting is the process of creating a plan to spend your money. This spending plan is called a budget. Creating this spending plan allows you to determine in advance whether you will have enough money to do the things you need to do or would like to do.
  3. 3. Why is budgeting so important? Since budgeting allows you to create a spending plan for your money, it ensures that you will always have enough money for the things you need and the things that are important to you.
  4. 4. BUDGETING TECHNIQUES
  5. 5. ZERO-BASED BUDGETING A method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a "zero base," and every function within an organization is analyzed for its needs and costs.
  6. 6. INCREMENTAL BUDGETING An incremental budget is a budget prepared using a previous period's budget or actual performance as a basis with incremental amounts added for the n ew budget period. The allocation of resources is based upon allocations from the previous period. This approach is not recommended as it fails to take into account changing circumstances. Moreover it encourages "spending up to the budget" to ensure a reasonable allocation in the next period. It leads to a "spend it or lose" mentality.
  7. 7. ADVANTAGES OF INCREMENTAL BUDGETING Conflicts should be avoided if departments can be see n to be treated similarly. Managers can operate their departments on a consistent basis. The system is relatively simple to operate and easy to understand. The budget is stable and change is gradual Co-ordination between budgets is easier to achieve. The impact of change can be seen quickly.
  8. 8. DISADVANTAGES OF INCREMENTAL BUDGETING Assumes activities and methods of working will continue in the same w ay.No incentive for developing new ideas. No incentives to reduce costs. Encourages spending up to the budget so that the budget is maintained next year. The budget may become out of date and no longer relate to the level of activity or type of work being carried out. The priority for resources may have changed since the budgets were set originally. There may be budgetary slack built into the budget, which is never reviewed-managers might have overestimated their requirements in the past in order to obtain a budget which is easier to work to, and which will allow them to achieve favorable results.
  9. 9. FLEXED BUDGETING OR FLEXIBLE BUDGETING A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is more sophisticated and useful than a static budget, which remains at one amount regardless of the volume of activity. As with zero-based budgeting, the flexed budgeting system gives its name away in the title as it involves ‘flexing’ the normal budget.
  10. 10. ADVANTAGES OF FLEXIBLE BUDGETING Usage in variable cost environment. The flexible budget is especially useful in businesses where costs are closely aligned with the level of business activity, such as a retail environment where overhead can be segregated and treated as a fixed cost, while the cost of merchandise is directly linked to revenues. Performance measurement. Since the flexible budget restructures itself based on activity levels, it is a good tool for evaluating the performance of managers - the budget should closely align to expectations at any number of activity levels. It is also a useful planning tool for managers, who can use it to model the likely financial results at a variety of different activity levels.
  11. 11. Budgeting efficiency. Flexible budgeting can be used to more easily update a budget for which revenue or other activity figures have not yet been finalized. Under this approach, managers give their approval for all fixed expenses, as well as variable expenses as a proportion of revenues or other activity measures. Then the budgeting staff completes the remainder of the budget, which flows through the formulas in the flexible budget and automatically alters expenditure levels. This approach can improve the efficiency of the budget formulation process, especially when the management team is working its way through a large number of iterations.
  12. 12. DISADVANTAGES OF FLEXIBLE BUDGETING Formulation. Though the flex budget is a good tool, it can be difficult to formulate and administer. One problem with its formulation is that many costs are not fully variable, instead having a fixed cost component that must be calculated and included in the budget formula. Also, a great deal of time can be spent developing cost formulas, which is more time than the typical budgeting staff has available in the midst of the budget process. Consequently, the flexible budget tends to include only a small number of variable cost formulas.
  13. 13. Revenue comparison. In a flexible budget, there is no co mparison of budgeted to actual revenues, since the two nu mbers are the same. The model is designed to match actual expenses to expected expenses, not to compare revenue lev els. There is no way to highlight whether actual revenues a re above or below expectations. Closing delay. You cannot pre-load a flexible budget into the accounting software for comparison to the financial statements. Instead, you must wait until a financial reporting period has been completed, then input revenue and other activity measures into the budget model, extract the results from the model, and load them into the accounting software. Only then can you issue financial statements that contain budget versus actual information, with variances between the two. These extra steps will delay the issuance of financial statements.
  14. 14. Applicability. Some companies have so few variable costs of any kind that there is little point in constructing a flexible budget. Instead, they have a massive amount of fixed overhead that does not vary in response to any type of activity. For example, consider a web store that downloads software to its customers; a certain amount of expenditure is required to maintain the store, and there is essentially no cost of goods sold, other than credit card fees. In this situation, there is no point in constructing a flexible budget, since it will not vary from a static budget.
  15. 15. THANK YOU!

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