The downturn has rendered budgets agreed last year largely irrelevant. Analyse Managers in business make decisions that affect profitability of business. For the decision to be effective and successful, it is important for organisation to plan and coordinate the decision. (CIMA official terminology, 2005) defines budget as an expression of a plan that is quantitative and can be defined over a period of time. Traditional budgeting as offered a lot of contributions in many years. Research shows that it seems it is more unsuitable for the modern business.
The objective of this essay is to explain what budgeting is, the purpose of budgeting, types of budgeting, definition of annual budgeting, its advantages and disadvantages, definition of rolling budgets and it advantages and disadvantages.
Budgeting serves a number of useful purposes.
These include:
The generally purpose of budgeting is to estimate and predict the future financial performances.
There are different types of budgeting, which are incremental budgeting, zero based budgeting; priority based budgeting and rolling budgeting.
The format of preparing budgeting may be similar but each of the basic approaches has relative advantages and disadvantages.
Incremental budgeting is also known as traditional or annual budgeting. It’s a method of budgeting based on the past and actual results, for example adjusting for known changes and inflation (CIMA official terminology, 2005). It is also used as a base for preparing budgets with additional amounts added to the current budgetary periods. The idea of incremental budgeting is that it is easy to understand thus it is easy to operate.
Incremental budgeting has several advantages. It is simple and easy to prepare. The method is consistent with the line of authority and responsibility in the organisational unit which can be applied to any organisations whether big, small or medium sized because of its flexibility. The main advantage is that it is much more straightforward than ZBB or using rolling budgeting (Drury, 2009). It conserves time and energy, it give better and general understanding which is accepted by government board members and legislators (Smart, 2004).
However, incremental budgeting continues to fail to meet today’s business demands. The major criticism is that incremental budgeting process is incapable of meeting the demands of the new competitive environment. Thus, the cost of non-unit level activities becomes fixed and inefficient. It also encourages wasteful spending which makes it difficult to maintain the main concept of budgeting. When the budgets does not relate with the past working activity level, it tends to become outdated. With this form of budgeting, there are no incentives because it tends to be a percentage of increase in budgets yearly. It also does not consider changes in the priorities of a company, from the previously set budget therefore creating disappointments (Drury, 2009).
The problems with incremental budgeting have given a rise to new method of budgeting such as rolling budget. Rolling budget can be define as a budget that is updated continuously, increasing a further accounting period (month or quarter) when the newest accounting period is outdated. Its use is specifically good where future costs or activities cannot be predicted correctly (CIMA official terminology 2005). Rolling budget is reliable because it allows for update of the budget every time there is subsequent deficit in budget (due to economic increase or decrease).
Rolling budget is reassessed regularly which makes it more realistic and accurate compared to annual budgeting. The uncertainty of rolling budgets is lessen since it is revised regularly. Therefore it can be said to be very useful in period of an increase in inflation. The planning and controlling is based on recent and updated plans because the budgets are continuous as it is always extended a numbers of months ahead. Rolling budgeting is suitable for large organisations such as Texaco, Volvo and Bulmer because it considers the economic changes (Drury, 2008). Although rolling budgets has advantages, however it has disadvantages as well. It takes time and it is expensive as it requires a number of budgets to be produced during the year. The amount of work needed with each reassessment of the budget can be off-putting for managers.
Each revised budget may require revision of standards or stock valuations which is time consuming. Zero based budgeting is a method of budgeting that needs all costs to be particularly justified by the goods expected (CIMA official terminology, 2005). It helps to remove long standing inefficiencies, helps to minimise waste and focuses attention on the value for money although it takes times and may need management to develop and learn new skills (Drury, 2008). Priority based budgeting are budget whereby budget requests are accompanied by a statement outlining the changes expected if the prior period budget was increased or decreased by a certain amount or percentage. It is suitable for non-for-profit organisations that have issues with long-term strategic planning and resource allocation.
“The downturn has rendered budget agreed last year largely irrelevant” this statement is true to some extent, base on the criticisms of budgeting and beyond budgeting which state that budgeting does not reduce cost rather it protect it. Budgets are time consuming, expensive and sometimes it fails to focus on shareholders values. It prevent fast respond, too rigid and it does not focus on customers satisfaction instead it focus on sales targets and can lead to unethical and dysfunctional behaviour such as building slack into the budget (Hope and Fraser, 2003). The Beyond Budgeting Round Table (BBRT) said “traditional budgeting is not only inflexible and inefficient; it is a borderline evil that contributed to notorious corporate scandals such as Enron and WorldCom.” (BBRT et al, 2007, cited in Stokdyk J. et al, 2006).
However, in spite of the criticism research shows that both financial and non financial managers and companies still uses budget because they thought that they were important for planning, controlling, performance, communication, measurement and coordination. Traditional budgeting still has its advantages over the other forms of budgeting not only because it works but because unlike the zero-based and rolling budgeting, incremental budgeting is way less expensive and less complicated to implement. Also the rolling budget is time consuming due to regular budgeting whereas incremental budgeting is done once annually. The rolling budgeting is updated regularly therefore making it more accurate compared to annual budgeting. It may not be suitable for all kind of organisation, but can provide value where appropriate. Companies have seen greater volatility in demand and might adopt rolling budgeting.
In conclusion, the main advantage of budgeting is to estimate and predict the future financial performances, although it is time consuming and very expensive. Incremental budgeting is simple, understandable and less complex to apply. It is suitable for all kinds of organizations, profit and non-profit organization. The major disadvantage of incremental budgeting is the incapability of meeting the demands of the new competitive environment. While rolling budgeting is reassessed regularly which makes it more realistic and accurate compared to annual budgeting. It main disadvantage is that it takes time and it is expensive as it requires a number of budgets to be produced during the year.
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