Budgeting Techniques: Flexible, Fixed, Zero-Based & Performance
Budgeting Techniques
Advantages of a Flexible Budget
- It is a very useful device for controlling costs.
- It is very useful in unpredictable environments.
- It shows the impact of varying levels of activity on profits.
- It facilitates production and profit planning.
Steps in Creating a Flexible Budget
- Identify the relevant range of activity.
- Classify costs according to variability.
- Determine variable costs.
- Determine fixed costs.
- Prepare the budget for selected levels of activity.
Fixed Budget
A fixed budget is designed to remain unchanged irrespective of the level of activity attained. It does not change with changes in the level of activity. This type of budget is most suited for fixed expenses. It is a single budget with no analysis of cost.
Budget Classification
Functional Budget and Master Budget
Functional Budgets
Functional budgets are prepared by heads of functional departments for their respective departments and are subsidiary to the master budget. Functional budgets may be operating budgets or financial budgets. Operating budgets relate to the different activities or operations of a firm and are the primary budgets. Financial budgets incorporate financial decisions of an organization, detailing the inflow and outflow of cash and the overall financial position.
Master Budget
The master budget is the summary of all functional budgets. It summarizes sales, production, purchase, labor, finance budgets, etc. It is considered the overall budget of the organization.
Zero-Base Budgeting (ZBB)
Zero-base budgeting is a method of budgeting that requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time. Without approval, the budget allowance is zero. Under ZBB, programs and activities are evaluated and ranked from a zero base as if they were launched for the first time. This technique of budgeting drops unwanted projects and activities and includes wanted and desirable activities and projects in the budget.
Features of ZBB
- It starts from zero.
- All activities are identified in appropriate decision packages.
- All programs are considered totally afresh.
- A detailed cost-benefit analysis of each program is undertaken.
- There is an officer responsible for each decision package.
Performance Budgeting
Performance-oriented budgets are established in such a manner that each item of expenditure related to a specific responsibility center is closely linked with the performance of that center.
Features of Performance Budgeting
- Objectives of the organization and for which funds are requested.
- Cost of activities proposed for the achievement of these objectives.
- Quantitative measures to measure performance.
- Quantum of work to be performed under each activity.
Preparation of Financial Budget
It includes cash budget and capital budget.
Cash Budget
It is prepared only after all the other functional budgets are prepared. It is also known as a financial budget. It is a statement showing estimated cash inflows and cash outflows over the budgeted period. The cash budget is prepared based on the cash forecast. The cash forecast is an estimate showing the availability or otherwise of an adequate amount of cash in a future period for meeting operating expenses and all other commitments.
Capital Budget
This budget represents the estimated expenditure on fixed assets during the budget period. It includes such items as plant addition, new building, land, etc.
Principal Budget Factor
The principal budget factor is the constraining factor that ultimately determines the level of activity planned. It is the area that cannot be increased to match the capacity of other areas.