Report on budgeting methods and processes

By

Course
Tutor
University
Department

19th April, 2019

Budgeting

A detailed monetary plan which outlines income plans and expenditure in respect of the future

period of time is what can be referred to as a budget. Based on agreed goals of that future

period of time, a budget is prepared prior to the period of time in combination with strategies

formulated to achieve those objectives. During budgeting, every separate function of the

organization always prepares its own budget. Usually, long term goals are the first to be set.

Before the long term plans are set, it is always vital to consider significant assumptions which

might result in critical implications on the future implementation of such goals. Implementing

these long term objectives then translates into strategies for achieving short term objectives.

Any major assumptions that may later spark questions in the organization must be noted. The

serious element that defines all other budgets in business is forecast, (Veiga et al., 2015).

Since businesses are meant for profit making, every part of a business always works towards

achieving that goal. Since every part of an organization prepares its own budget, all of the

budgets are prepared at the same time for purposes of communications amongst

organizational managers working in various capacities. Processes that companies need to follow

while preparing a budget

Communicate objectives and strategy

The strategy document has to include a long term plan. This is always calculated with the

organization at intervals all year round. Those charged with the responsibility of preparing

budget must be able to understand the process of budgeting since in entails regular circulation,
with an invitation to comments and observable procedures of review for purposes of

accommodating changes in circumstances (Meliano, 2011).

Communication of processes

In order to communicate the processes of the budget within a firm, a budget manual must be in

place. When the budget manual is in place, it will be easy to draft a timetable for preparing the

budget, formats to be used, flow list for preparation and negotiation procedures where

conflicts originate from.

Determining factors that are critical

The initial point of the budget is always set out by the critical factor. Obviously, the critical

factor for many organizations is sales. In the production of goods and services, there is no

reason for producing what does not sell. In some situations, there may be no problem with

demand but the supply of skills and materials may be limited (Lubis et al., 2014). (Since

materials will be eventually being obtained at higher prices with labor migrating from one

geographic location to another in search for skills, such a situation must be temporary in a

competitive market. In this discussion, it will be assumed that sales are a critical factor.

Preparation of the starting set of budgets

The sales budget represents the bulk of for a planned budget, multiplied by the anticipated

selling price of each item. The volume of sale is the key unknown item since it depends on the

consumer’s choices which are extremely difficult to predict. Some market research will have to

be carried out, in general, that is to say from complex to simple market research methods
which can include interaction with clients and asking them about their past and intention for

future periods of time. Since this is the responsibility of sales agents, it is their role to formulate

continuous demand estimates, (Faust, 2008). Analysis of the past sales performance can be

useful in the identification of trends which may predict the success or failures of future sales.

From the flow of sales plan the Operational budgets, the production plan, establishing resource

input quantities needed, leads into operational budgets for direct labor, direct materials and

manufacturing overhead which combine resource quantities expected per unit. At the same

time, administration budgeting and marketing are being prepared to base on the quantities and

resource prices required for production and sales, (Agha, 2007). This information is useful in

delivering the basis for a loose and a profit account matching expenses and sales. Estimation of

cash flow is also needed basing on the needs of working capital and fixed asset requirements.

The creditors planned to support production, debtors, production levels expected are what

working capital depends on the capital projects budget for as outcomes of organizational

objectives are what fixed assets derive from, (Faust, 2008).

As a result of all the above, a finance plan from which the master budget emerges comprising of

the budgeted profits and accounts of loss, the budgeted balance sheet and the statement of

cash flow.

Negotiation of budget managers of line

A successful process of the budget is heavily dependent on the entire participant’s degree of

involvement in the process of budgeting.

A bottom-up budget

This process begins by requesting those who are charged with the implementation of the

budget to make proposals and participate in the procedures of budgeting. This gives them a

sense of ownership but it does not give the full control of the budget.

Top-down budget

This process of budget begins with organizational senior managers and the budget is sent down

to implementers with targets basing on the strategies and goals of the organization. In other

words, the budget is imposed on those who implement it without them being involved in

sharing the participation process. A negotiated budget comprises of both top-down and

bottoms-up budget methods with the aim of setting budget allowances as outcomes of

negotiation between those who implement the budget and the senior managers (Meliano,

2011).

In negotiated budgeting, each department of the organization prepares its own budget but

each budget may have an implication on the lines of other managers. A cut in initial

expectations may be necessary in case of situations where resources are restricted. Negotiated

budgeting brings an opportunity for discussion between implementers and managers so that

the budgeting can benefit the entire organization in a more efficient way.
Coordination and review of budgets

Although the negotiate budgeting process may end up satisfying the interests of both the

implementers and managers, the budgeting committee must ensure that the budget is in line

with the interests of the organization in general. Separate budgets from the negation processes

are brought together for purposes of coordination to find out whether they are in line with the

strategies of the organization, (Lubis et al., 2014).

Reviewing of budget

This involves the comparison of the prepared budget with the previous budget for

reasonableness. This process emphasizes the effective use of cash and the link between

performance indicators and the budget request. For instance, there may be a need for

increased resources to bests performing departments to maintain hat high performance.

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How budgeting benefits a company

Planning

Preparing a budget compels business managers to formulate a planning exercise which is aimed

at identifying each part of the business and bringing separate parts together based on quantity.

Key planning decisions are made as portions of long term planning procedures which are then

fine-tuned into increasingly broader details while being turned into immediate plans of

operations by the managers, (Dorotinsky, 2004). This formal planning encourages every part of

a business to contribute to the formation of general planning and identifying problems at an

early stage.

Control

When managers have a budget as a basis for comparison, they are able to identify exceptions

that may need special attention. This is helpful in developing corrective measures and actions

for tackling problems at an early stage. Variations between results and budget prospects can

indicate the necessity for managers to revise the budget. Modification of the budget needs if

budget variations are coming from uncontrollable circumstances and if budget variations arise

from the manager’s line of control then action can be necessary rectify the causes of the

problems, (Dorotinsky, 2004).

 Coordination and communication

Communications lines help in ensuring that all sections of the company are fully informed of

policies and plans, and the constraints which such plans are formed.

The basis for evaluation of performance

Within a company, evaluation of performance will be required at a particular stage. No matter

what kind of performance evaluation, the performance of individuals or groups must be set in

advance and be known to all participants hence budgeting is good for setting performance

targets in a systematic way, (Schick, 2003).

Vision statement
Snappy Drinks Plc. intends to launch a new range of health – led drinks by using a variety of low –
fruit exotic fruit flavors which will lead to the rollout of 15 new products. The founder and CEO of
the company is Donna, she owns 15% of shares in Snappy Drinks.
Having anticipated UK’s departure from the EU, Donna wants to set up promotional efforts into the
Gulf, North America, and the Far East, especially China.
Objectives
 To rollout 15 new products
 To expand the market.
 To establish new manufacturing facilities in the Gulf, North America, and the Far East,
especially China.

Snappy Drinks Plc.

Sales and production volumes and direct costs

Budgeted sales 687 million

Add: Desired ending inventory 136 million

Total needs 75 units

Less: beginning an inventory 60 units

Required production 15 units

Traditional budgeting

Traditional budgeting entails a budget set that is done basing on the circumstances of the

previous year. In this kind of budgeting, some adjustments for changes in factors that are

expected to have effects on the forthcoming budget. In this kind of budgeting, the management

(budget holder) is allocated a sum of money that will be spent in areas of critical concern. They

are known as the discretionary budget. Central governments and local government are the

primary users of discretionary budgets, (Schick, 2003).

If this is compared to the usage of raw materials budget in a manufacturing business, where the

number of materials used, the number of funds involved, is visibly connected with the level of

production and, eventually to the volume of sales, with no vibrant benefit, the incremental

budget can consume all the resources. Therefore, the only seasonal increment can be proposed

since they are easy to sustain implying that traditional budget is all good for small businesses

but has a lot of disadvantages for larger organizations, (Agha, 2007).

Analysis of the applicability and limitations of traditional budgetary systems in a company

Simplicity

The simplicity of the traditional budgeting is what makes it ideal for larger companies. This is

because of the companies that use this kind of budgeting method don’t have to rethink or

review every item that is listed on the budget. Instead what is considered, is the spending of

the previous year and then what can be done is to deduct or add the current market situation,

rate of inflation, the demand of consumers.

One of the key advantages of traditional budgeting is that it offers a solid framework. Basing on

the data points of the previous year makes it very easy for managers to effectively handle

financial activities of the company. The solid framework offered by traditional budgeting is

easier to execute and easier to control but the major drawback of traditional budgeting is that

inaccuracies are inevitable because of reliance on the data points of the previous year . With

traditional budgeting, it is difficult to ensure accuracy since little attention is paid to rethinking

and reviewing of each item on the budget list of the previous year.

Is traditional budgeting good for all companies?

Yes, this budgeting approach may work for companies irrespective of whether they are big or

small. The only thing companies have to do is to make sure they don’t a lot of overheads to be

included in the preparation of their budget, otherwise zero based budgeting is superior in terms

of efficient resource utilization.

Other alternative methods of budgeting

Zero-based budgeting (ZBB)

In zero budgeting, all spending must be justified. For instance the fleet budget for each year, it

is not automatically mean that the purchase of vehicles should be financed in the future just

because they were purchased this year. The vehicle purchase budget will have to start from

zero bases unless there is a good reason for the business to spend scarce resources on purchase

of new vehicles. It is always necessary for the top managers to be convicted that they propose

spending that reflects value for money (Meliano2011).

ZBB encourages management to adopt a more questioning approach to their responsibility

areas for purposes of justifying the resource allocation. ZBB compels managers to think

carefully about specific activities and ways in which they are carried out. This questioning

approach then translates into more efficient utilization of the company’s resources. Where

there is no clear link between input and output is where most increases in the portion of the

total costs of a company come from. Here the commitment of resources will be discretionary

rather than being essential to production hence the relevance of ZBB.

Rolling budget

A rolling budget is when the category of amounts rollover from one month to another. This

implies that a company can start with a negative balance in a category from the previous month

or that a firm builds up extra funds in categories to cover expenses that fluctuate from month
to another. Like many other budgeting methods, a rolling budget to have both advantages and

disadvantages.

The advantages of rolling budgets are outlined as below:

 In highly unstable industries, rolling budgets help to minimize uncertainty in the

process of budgeting. This is because in volatile industries the levels of prices and sales

may fluctuate.

 It compels managers to regularly review the budget.

 Motivation in companies is usually aided by more realistic budgets.

 Control and planning are always grounded on current information covering a

critical future time.

Disadvantages of rolling budgets include:

 It requires a lot of time and resources.

 Continuous inspection of budgets is monotonous and disruptive.

 Where changes are not continuous, continuous reviewing of the budget may not

be necessary.

An attempt to adopt rolling budgets in large firms and government institutions will certainly

come with some problems. Large organizations have fixed limitations over the period of

budgeting and therefore rolling budgets can only be adopted in particular business entities and

public entities if the entire budgeting system is transformed.

Activity-based budgeting

This is a budgeting method that developed from the activity-based costing that is normally

applied by private entities. What motivates the costs through linking activities to overheads is

what this method tries to identify instead of forging a relationship between the volumes of

production and overheads. The information needed for the preparation of budget becomes is

to obtain since production plan changes are made in relation to the cost changes, (Agha, 2007).

However, the preparation of budgets is still meant to represent an activity-based costing

method. This approach is still in its initial development stage since the availability of

information on associated cost motivators and activity bases is limited. The outcome of this is

that all activities are like overheads are allocated to activities basing on features which are

assumed to be the motivators of such costs.

Activity budgeting comprises of the following major phases: the objectives of these phases

aimed at:

 The Identification of the activities of the organization.

 Determining the motivators of drivers.

 Spreading the costs of departments to drivers of costs.

 Calculation of levels of budget activities. The activity-based budget model has

some of the following merits:

 Costs of activities are identified.

 Resource allocation at different levels of activities is possible.

 A relationship between cost behavior and decision making is established.

  There is a possibility of fitting it within the control system.

The demerits of activity budget include:

 Identification of cost motivators may be difficult.

 Monitoring activity-based budgeting on a regular basis is not easy, especially in

the immediate term.

 A complete reassessment of a company’s managerial systems and accounting

system is always required.

How worthy is zero-based budgeting to a company

Depending on the above merits and demerits of zero-based budgeting, the following are zero-

based budgeting for a company:

 The adoption of the Zero-based budgeting system in a company is commercially

viable especially when resources are scarce.

 In situations where cutting the budget is necessary for handling severe

processes.

 Achieving financial discipline is possible with zero-based budgeting since it

involves a thorough and appropriate assessment of each department of the company.

 It allows the timely preparation of approved estimates.

 Managers are held accountable for their financial decisions.

Companies should, therefore, adopt ZBB for maximization of efficiency in as far as resources

utilization is concerned (Tirimba 2015).

References

Veiga, L. G., Mathew, K. & Reza, A. 2015. Intergovernmental fiscal relations: Questions of

accountability and autonomy. Springer briefs in environmental science conference proceedings.

Meliano, S. 2011. Survey of management perception on the usefulness of zero based

budgeting: Evidence from nongovernmental organizations in Kenya, University of Nairobi,

Kenya

Lubis, A., Hasan, S. &Fausi, S. 2014. A Study on the different applications of performancebased

budgeting and zero-based budget on regional task force unit in North Sumatra. International

Journal of Management Sciences and Business Research, 310

Mohamed, A. I., Evans, K., &Tirimba, O. I. 2015. Analysis of the Effectiveness of Budgetary

Control Techniques on Organizational Performance at Dara-Salaam Bank Headquarters in

Hargeisa Somaliland: International Journal of Business Management and Economic Research

1JBMER, 66, 327-340.

Dorotinsky, B., (2004). Developing a Medium-Term Expenditure Framework. Reforming

the Public Expenditure Management System, World Bank and Korea Development Institute,

Seoul.

Schick, A. (2003). The Role of Fiscal Rules in Budgeting. OECD Journal on Budgeting, Volume 3,

Number 3, OECD, Paris.

Agha, Z., (2007), Budget Reform at Sector Level: All bark and no bite?. Overseas

Development Institute Opinion Paper 90 , November, Overseas Development Institute, London

Faust, J., (2008). Are More Democratic Donor Countries More Development Oriented?

Domestic Institutions and External Development Promotion in OECD Countries. World

Development, 36(3),pp. 383-398