Performance Management and Control of the Organisation

5 Types of budget

5.1 Fixed budget

This is a budget prepared at the anticipated level of activity.

If the expected level of activity changes during the period, then the fixed budget becomes unrealistic and will usually be flexed (see below) for use as control.

However, the original fixed budget still very often remains as an overall target – for instance, the profit from the fixed budget will often have been given to head office and used as the target for the period.

5.2 Flexed budget

A flexed budget is when the budget is revised (or flexed) to reflect the actual level of activity.

This budget is useful particularly for control purposes and is what we use in our variance analysis.

5.3 Rolling budget

A rolling budget is one that is kept continually up-to-date by revising at the end of each month and also adding a further month.

For example, on 1 January 2008 prepare a budget for the year to 31 December 2008.

At the end of January 2008, revise the budget for the remaining 11 months of 2008 (in the light of what happened in January), and also prepare a budget for January 2009.

In this way there is always a budget for the coming 12 month period.

The benefits of rolling budgets are that they are likely to be more accurate, and also the work-load of budgeting is spread throughout the year and becomes part of the normal job – again leading to more accurate budgeting.

6 Methods of budgeting

6.1 Incremental budgeting

This approach is to take the previous year’s results and then to adjust them by an amount to cover inflation and any other known changes.

It is the most common approach, is a reasonably quick approach, and for stable companies it tends to be fairly accurate.

However, one large potential problem is that it can encourage the continuation of previous problems and inefficiencies. All too often the new budget is worked out by taking last year’s figures, then adding an amount for inflation (and often adding another amount for ‘padding’). If we require a wages budget, we will probably ask the wages department to produce it and they (using an incremental approach) will assume that our workers will continue to operate as before. They will therefore simply adjust by any expected wage increases.

As a result, the ‘plan’ for our workers stays the same as before. Nobody has been encouraged to consider critically different ways of operating that may be more efficient. It is at budget time that we perhaps should be considering different ways of operating.

6.2 Zero-based budgeting

With zero-based budgeting we do not consider the previous period. Instead, we consider each activity on its own merits and draw up the costs and benefits of the different ways of performing it (and indeed whether or not the activity should continue).

We then decide on the most effective way of performing each activity.

Clearly any changes to the way an activity is performed may require funding, and there may not be sufficient funding available for all changes proposed, and therefore they are ranked to decide which changes are made.

Although this approach is in principle a much better approach to budgeting, it is time-consuming and also requires much more expertise than incremental budgeting. For this reason, it is often restricted just to a few activities each year in order that training and help may be given to the people involved. Other activities are budgeted using the incremental approach.

6.3 Activity Based budgeting

This is the application of the idea of Activity Based Costing to the process of budgeting, and as such has particular relevance to budgeting for fixed overheads.

At the planning stage, attempts are made to identify which activities drive (cause) various overheads. Costs are spread over these cost drivers using whatever basis appears to be appropriate in the circumstances. A better understanding between costs and their causes should result in better budgets better decision making and better performance.