Budgeting is an essential accounting process for every scale of organization: small, medium, and large. It essentially reflects the expenditure and revenue receipts of an organization for a definite period, usually one year. A budget is prepared annually, and used as a reference for financial operations during this said period. Even non-commercial bodies like government departments and hospitals form an annual budget.
A budget could also be made for any specific task or project; for instance an exhibition or construction of a road. A statement of expenses associated with such specific task or assignment is also termed a budget. This is an accounting tool that summarizes the monetary involvement of these works. A budget is used as a yardstick for measuring price rise or fall in successive years. There are normally six types of budgeting:
- Activity based
- Performance based
Static model is the conventional form of budgeting where projections for an entire period, usually one year, is drawn up. A statement of expenses and earnings is created and efforts are made to stick to these figures. Activities of an organization or company are monitored so that these earnings and revenue figures conform as projected.
Operation of this budget is rigid and does not allow leeway of adjustments. As it is based on a single projected outcome its achievement is difficult. In a dynamic environment exercising a static budget model is difficult and retarding to development process.
Zero based budgeting
Zero based budgeting is followed by non-commercial setups where outcomes are pre-determined and fund allocation is made accordingly. Money allocated is supposed to be used up during a given period followed by fresh outcomes drawn for subsequent year. A new set of outcome-expenditure budget is created for every year.
In zero budget model a detailed description of expenditure needs to be justified. The advantage of this form of budget is its cost regulatory capacity. In service industries, where waste is negligible, this form of budgeting is more meaningful. The drawback of this model is its lengthy preparation time and its thorough approach.
This model of budgeting is ideal when time is a constraint. This model allows for a certain percentage increase of income and expenses in respect to previous budget. Unlike a zero-budget model where money allocated is to be spent within a given period, expenses could be rolled forward to consecutive year. This model is perfect for small organizations where there is not much scope of spending.
Budgetary process is short and fast. As avenues of expenses are not many, budget allocations for several years could be made at a time. This model is however not appropriate for medium or large organizations as their scope of expenditure are varied and complicated. As ‘incremental’ model does not involve detailed analysis of expenses made the method is not incisive.
Flexible budgeting model is best suited for marketing organizations as sales behavior is not always easy to project. Though every marketing office has yearly projections based on previous years’ results and future trends, an element of uncertainty always remains. A sudden change in price or in preferences of consumers could lead to an abrupt change in sales of a commodity. In marketing companies where yearly budget is closely linked to sales volume or revenue, a static budget is a constraint.
This budget model allows for periodic modifications in revenues earned and expenses made during an ongoing budgetary phase. Flexible budgeting should not be used for companies that are involved in multiple functional areas.
This is a common form of budgeting prevalent in educational institutes, government departments, and private enterprises. In this model of budgeting, decision making authority lies with the top management. This is so because only top level managers participate in financial decisions. These members have an overall view of the financial aspects of a business or service department. As they have overall control of an organization and oversee every functional area, it is easier for them to decide on avenues of revenue earning and expenses.
Centralized authority for an organization decides on sectoral spending or entire organization’s expenses. This budget model allows decision makers to choose between department-wise spending or centralized buying. On its flip side, this model removes competition among different departments thereby prompting them to show little interest in spending money.
Activity based budgeting
Activity based budgeting model focuses on the biggest return to expenses made. This model of budgeting is once again useful for service oriented businesses and organizations like hotels, universities, and hospitals. Here a group of individuals is given the responsibility of budgeting and its implementation. For universities budget allocation among departments could be made based on their activity level. Departments putting in more effort expectedly are allocated greater sums for spending. As learning institutes and service providers have limited revenue sources, linkage of their revenues and earnings are done easily.
Implementation of activity based budget entails sufficient time and involvement. For an institute that does not operate on a commercial scale, finding avenues of revenue generation is difficult making the process for budgeting tough.
Performance based budgeting
Performance based budgeting is similar to activity based budgeting since in the former ‘performance’ determines budget allocation, while in the latter it is determined by ‘activity’. In this model, budgeting is easy as ‘performance’ (which is measurable) is the determining factor for fund allocation. As the element of accountability is very high in this method of budgeting, there is complete transparency in the entire process of earnings and expenditure.
Rolling budget model
The rolling budget is comparable to ‘incremental’ and ‘flexible’ budgeting in that it always adds to its previous budget. In this way a budget always extends beyond its scheduled term and develops a rolling character.
This is the least used model as formulation of any specific budgeting process is not possible. The only advantage of using this model is for companies that have limited financial operations and do not have many variations of revenue earnings or expenses incurred.
To Sum Up
Budgeting as an accounting tool is essential for any form of activity, commercial or non-commercial. This accounting instrument is mandatory for commercial enterprises irrespective of its scale. Budgeting being a meticulous process involves the best financial talents and accomplished professionals.