Importance of Budgeting and Different Methods of Budgeting

This article discusses the importance of budgeting and the different methods of budgeting like traditional, zero-based and activity-based budgeting. It explains how to prepare a budget and the purpose of budgeting. The article also highlights the cost drivers for a company and the drawbacks and benefits of each budgeting method. It concludes by suggesting that a combination of budgeting methods should be used depending on the circumstances.

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Date: 04 April ,2018

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Contents
Part 1..........................………………………………………………………………………........2
Part 2........................................…………………………………………………………........8
Refrences……………………………………………………………….....................................11
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Part 1
i)The purpose of preparing a budget is that it helps in making an estimate of the income and
expenses for the company. Every company should prepare a budget before starting any project that will
help them in understanding whether the project would be beneficial or not for the company. It is
prepared based on the economic goals, boundaries of the company and focuses on the growth of the
company based on it (Alexander, 2016). The overall market scenario in which the company operates is
also taken into consideration. Budget will help in preparing the company for worst case scenarios
making it accountable for its total amount of expenditures. It helps in making the company aware about
its actual performance based on its estimated amounts. And then the company can analyse the reason
for its deviations that will help it in improving its performance in the future.
Preparation of the budgets contains the following steps –
 Choosing the budgeting model – There are various types of budgeting model available in the
market and out of that financial leaders can choose those models that are best suited to the
company dynamics. The two main types of budget are zero based budget and traditional
budget (Belton, 2017).
 Timing of Budget Preparation – Annual Budgets are prepared before the starting of the fiscal
period, budgets that are specific to projects are started before that project. Then some
budgets are prepared on monthly basis and quarterly basis. So all this helps in determining
the period during which the budget needs to be prepared by the company.
 Monitoring the Budget – Once the budget is applied, the management is expected to
function as per the same, which means the company should expense as much as it is
mentioned in the budget and vice versa. In case there are any deviations with the set
standards then the management of the company needs to analyze the same and take
necessary steps that will help in removing any such discrepancies in the system of the
company. Monitoring is an important function and the company needs to appoint experts
that can help the management in that regards.
 Take necessary steps – It is important to take necessary steps to monitor the budgets and
make sure that the company is taking necessary steps that will help them in reducing the
difference between the set standards and actual results. Thus it helps in highlighting those
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areas in which the company needs to put in extra effort, those areas that are affecting the
overall growth of the company and those areas in which the management can do better
with their improved skills and developing better technologies in times to come.
Purpose of preparing the budget –
 Budget helps the company in defining a proper plan to make all its expenses and channelize its
revenues so that in future there is more income from the projects undertaken by the company.
 It helps in organizing the overall activities of the company and helps in making sure that the
steps that the company takes are as per the budget that will help them in reducing wastage and
earning more income.
 It will also help the company in understanding the problem areas and understanding what are
the strengths and weakness of the company. It will help in improving the overall strength of the
company and reduce unnecessary wastage. So we see that this would lead to further growth of
the company.
 It will also help in judging whether the projects taken by the company are economically viable or
not and if they will help the company in generating more revenue in the future. The company
can also take help from experts that can help them in better analyzing the prospects of the
company for future projects and growth (Laursen & Thorlund, 2016).
ii) The important cost drivers for the company include the sales factor that will cover the entire sales
that the company is making. The cost of the products that the company is producing that will include the
raw materials that would be required for such kind of products. It will also include labour that the
company will need in factories to operate machines that would help in manufacturing of the products.
The traditional budgeting factors can be applied to such kind of business, as sales can be taken as the
basis for calculating the total amount of revenue and then from the same the company can deduct the
relevant amount of expenses, and other cost factors. For determining the total amount of cost the
company should consider the factors that might inflate the total cost that the management will incur
and how the same can be reduced in order to reduce wastage. The company should take help from cost
accountants that can help in making better valuation of the products and help the company in reaching
a particular minimum cost (Minnis & Sutherland, 2017). Once that is calculated the aim of the
management should be to make sure that there should be least deviation from the estimated cost and
the actual cost should not be much more than the estimated cost. This will help the company in
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maintaining a particular level of profitability in the market and also reduce unwanted wastage.
Traditional budgets have a large amount of benefits that the company can apply easily.
iii) A traditional budgeting system is the amount that a company allocates to certain expenses for a
specific time period for example rent, electricity etc. It helps in spending money as per a plan. On
analyzing the present situation of the company based on the circumstances present it can be said that it
would be better if the company applied the traditional method of budgeting to cost sectors that
fluctuated less to those in which there was high level of fluctuations, this is because traditional system is
good for such cost elements in which the company can allocate certain amount based on some time
period. But in situations in which there can be high amount of fluctuations, the traditional system
cannot be applied (Werner, 2017). Like in this case study there is a probability of a situation where there
can be such issues that might cause huge changes in the total cost element for the company. This might
hamper the cost for the company and might affect the overall revenue that the company will earn. For
those elements that are not recurring and occur once in a while, this process of traditional budgeting
will not apply. This is because the company is not aware while preparing the budget that these cost
might be incurred in future. Thus this method of traditional budgeting becomes nullified in this case and
then the company has to resort to other methods like zero based budgeting in which the cost elements
would be included based on their relevance to the project and the effect that it causes to the total
profitability of the company. In the planned future the company needs to analyze the nature of the
expenses that relates to the project, and see to it whether the same is of recurring nature or not and
then based on that the company should apply traditional or the recent advanced types of budgeting that
will help in ascertaining the total profit of the project. The focus should be to ascertain the type of cost
and then analyze the process in which it can be applied for the project. The company can hire experts
that can help in analyzing the various situations related to the project and help in ascertaining the total
results from the same (William, 1996).
Part 2
i)Rolling budgets helps in preparing budgets on a continuous basis, as in if the total period is of
12 months for the budget just as one moth gets over, another one is added, so that makes it continuous.
It is better than annual budgets, because annual budgets take a lot of time to be prepared, and also ties
up a lot of resources. In case of rolling budgets the process is clearer, as the company gets the chance of
make changes in the budget as the period passes and there is a lot of accuracy involved in it. It helps in
adjusting the budget to recent forecast and trends, and it is a driver based not based on past results. The
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drawbacks involved with this type of budgeting are that there may be lot of time and effort involved for
rolling the budgets every year. Training needs to be provided, if the accountants are going to forecast
throughout the period (Maynard, 2017). There will also be issue involved with how to evaluate the
performance of the company. But in many ways the method of budgeting is better and more dynamic
than traditional method and helps the company in better forecasting for results.
Zero based budgeting is a type of method in which all the expenses must be justified to be included in a
certain period. This process starts with a zero process and each element is analyzed on the basis of the
cost and the needs of the organization. The main difference between zero based budgeting and
traditional budgeting is that zero based budgeting evaluates the budgets every time it is prepared and
traditional based budgeting is a method in which the company takes the prior year as a base to prepare
the budget for the coming fiscal period. Traditional system is more accounting based and zero based
budgeting is more decision oriented. In traditional the focus is to maintain the past results and consider
the inflations that might occur through the years for the company. In case of Zero based the approach is
more dynamic from the company’s side, the package is done as per a comprehensive approach and the
cost is ranked as per relevance (Visinescu, et al., 2017). The clarity is higher in this type of budgeting.
There are fewer issues involved. The only drawback is that it is very complex and people need to be
trained so that they can apply this type of budgeting. It also requires time and effort from the company
to apply such kind of budgeting in the system.
In case of Activity based budgeting the revenues and cost are directly allocated to the activities that are
responsible for it. In this method, the conversion occurs where the company converts the each cost
elements into specific units and cost centres and accordingly they are divided. It is a more advanced
method of budgeting and is more dynamic in terms of applicability than Traditional method. The only
drawback is that the complexity level is extremely high. The management needs to appoint cost
accountants who can help them in analyzing these cost centres and allocating the revenues and
expenses. But it gives a clearer picture to the management with respect to where the management is
spending its funds and which activity is more responsible for it. The drawbacks are that the cost and
effort of implementation of such system is very high and requires a lot of analysis (Belton, 2017)
ii) These methods can be applied by the company in specific situations like revised contracts with local
authorities, where the company feels that there can be changes to the overall cost element and
traditional system of budgeting cannot be used there, the management can opt for such methods like
zero based budgeting that analyzes the need and relevance of each cost to be included in the system. In
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cases where the company goes through many significant changes with respect to its cost and revenues
the company can apply other methods of budgeting that will help in removing all kinds of bugs that are
present in the system and help the company in delivering greater results in times to come. In 2019, the
traditional system might not be that effective in terms of assimilating every element that affects the
growth of the company and its overall finances, thus there are other methods that the company needs
to look for and make significant changes, that will help in ascertaining the current financial position of
the company and also help in making specific changes (Kew & Stredwick, 2017).
iii) The company can use whether one single method of budgeting or a combination of it depending
upon the circumstances that are relevant to the company. Each of these methods have their own pros
and cons and the company can make use of it to deliver great results. But given the fact that each
method will require a lot of time and cost to get implemented and get the desired results, it would be
better if the company makes these changes in the traditional system step by step. Initially the
companies should make use of traditional system and then switch to more diverse methods like activity
based costing or zero based costing. Out of all the methods the most relevant method for the company
would be zero based costing that will analyze whether the cost should be included depending upon its
nature and relevance (Bromwich & Scapens, 2016). It helps in providing accurate results, is more flexible
in terms of application and will lead to great results in times to come. Other methods like activity based
costing can be applied in factories, where every cost can be divided into cost centres and accordingly the
companies can allocate the cost and revenue to these centres. Thus the aim should be to use a
combination of these methods rather than a single budgeting method, but the process of application of
change should be very seamless and gradual. It should occur step by step and not in a day. The
traditional system has its advantages that cannot be ignored, but it is redundant in the current period.
Thus it becomes important in every way to allocate the cost to other cost sectors based on different
methods of budgeting that would help the management in generating better results in the future.
Budgets are prepared so that the company is able to forecast beforehand the areas in which there will
be more expenses and revenues and can accordingly decide its path of functions and objectives. Thus it
can be said that it is relevant for long term success and growth of the company and the management
should take expert help that can help them in ascertaining which methods are the best that can be
applied (Alexander, 2016).
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References
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Bromwich, M. & Scapens, R., 2016. Management Accounting Research: 25 years on. Management
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Kew, J. & Stredwick, J., 2017. Business Environment: Managing in a Strategic Context. second ed.
London: Chartered Institute of Personnel and Development.
Laursen, G. & Thorlund, J., 2016. Business Analytics for Managers: Taking Business Intelligence Beyond
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Minnis, M. & Sutherland, A., 2017. Financial Statements as Monitoring Mechanisms: Evidence from
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Visinescu, L., Jones, M. & Sidorova, A., 2017. Improving Decision Quality: The Role of Business
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