Techniques of budget preparation

Techniques of budget preparation

There are mainly two types of budget preparation techniques used

1. Participation Budget
2. Imposed Budget

1. Participatory Budget

Under this technique the lower management effectively participates in the budget preparation process and mainly their recommendation is incorporated in the budget. The participatory technique of budget preparation is suitable in relatively medium scale organization.

Advantages of participatory Budget

1. Commitment

The manager will shoe more commitment to achieve the target set by them. The participation will act as motivating factor for the junior management and it will have a positive impact on the performance of the junior management.

2. Improve communication

This method will improve bottom to up communication. This will help top management to understand the problem at lower level. This technique will also identify the potential of junior management and junior management talent may be utilized effectively in future.

3. Confidence

This method will improve the confidence of the lower management and give him a motivation to work harder for achieving the organization objective. This technique will also have positive psychological effects on the junior management.

4. Accuracy

The lower manager can project the figures more accurately because they are more related to operations and they have more detail knowledge of operations. They will prepare a budget after considering all the relevant facts and figures. Therefore the budget would be more appropriate.

Disadvantages of participative budget Technique

1. Overall Direction is lost

The lower tier management has little idea about overall direction of the organization. The focus only on operational level issues in budgets preparation. For example the junior management may be interested in more efficient methods and dot care about the cost of acquiring those methods while on other hand top management is pursuing a cost saving policy.

2. Conflict

The rejection of budgets by the senior management may create resentment and conflict in the organization. The rejection may be considered as de motivating factor for the junior management and it will adversely affect the performance.

2. Imposed Budget

The budgets are prepared by the senior Management and junior management is informed to achieve the targets. There is no effective involvement of junior management in decision making process.

Advantages

1. Time Saved

Because the decision making is in few hands therefore immediate decision can be made.

2. Overall Direction

This technique helpful to achieve the overall direction of the organization as senior management set the overall direction and they prepare the budget keeping in mind the strategic objective.

Disadvantages

1. Challenging Targets

The target set may be too challenging to achieve. This situation may create resentment in junior management. This situation will also create un due pressure on junior management to achieve un realistic target set by budget.

2. Demoralization

The junior management will have low moral over due to non consultation. The junior management will feel powerless and this will adversely affect the performance.

3. Poor communication

This technique there will be very little communication process between top management and the top management would not be able to incorporate the operational aspect in the budget. There will be over focused on strategic objective and importance of operation in achieving the overall objective is ignored.

Purpose of Budget

Purpose of Budget

1. Communicate the plans

The budgets may be a source of communication plans to the relevant manager. Because the budgets are formal documents of the organization and prepared in a formal and structure way. Therefore it is not possible for manager to ignore the budgets.

2. Budget Set Targets

Budget can set performance targets for the organization and budget can be used as source document to evaluate performance of the manager. The performance evolution is critical for the employees because usually it is linked with the reward announcement for the employee. Therefore budget can play important role for improving the performance of manager and employees.

3. Budget set Limits

When the budgets are formally approved then it becomes an authorized expenditure limits and any expenditure which does not fall under these limit require special approval. Furthermore any expenditure which is not mentioned in the budget will also go to management for approval. Therefore budget put an effective control over expenditure.

4. Set a Direction

Budget is basically linking different department in formal way. Budget is prepared in a structured way and it takes into account the every department and therefore budget set a direction of moving forward. The budget is a linkage between different departments. Each department can get an idea about other department direction and activities from the budget.

5. Budget is Medium Term

The budget is normally considered to be a medium term plan and it provides a linkage between short term and long term planning. The budget is normally prepared for one year keeping in view the long term objective of the organization. The budget gives a direction to short term plan for achieving the long term plan.

Stages of budget preparation

1. Identify the key budget Factor

The first step is to identify the key factor for budget. The normal key factor is sales

2. Prepare budget for key factor

The second step is to prepare sales budget. The sales budget provides bases for other functional budgets. Therefore a great care must be exercised while preparing the sales budget. If budgets of key factor are not accurately prepared the whole process of budget will be at stake.

3. Other function budget

The other functional budget will be prepared in logical sequence. The typical sequence would be budget for production, and then budget for inventories, labor .

4. Submit the budget

The budget is submitted to the budget approving authority for review. The budget is reviewed by the budget committee and budget is explained to budget committee. The committee may require the further explanation and may also recommends the changes in the proposed budgets. The budget is amended in accordance with recommendation of the budget committee.

5. Master Budget

The functional budgets are incorporated into master budget. The master budget is overall budeget for whole organization.

6. Approve the budget

Submit the budget to board of director for approval. The key objective is explained to board of directors and board of director approves the budget in principal. The budget may be approved by board of director without any change or may approve the budget after some changes and amendments.

7. Communicate the budget

The budget is communicated to the relevant manager for implementation. The manager has a formal approved document in their hands and this document provides a basic guideline for activities to be carried out and range of those activities especially in financial terms.

8. Monitor the budget

The budget may be divided into shorter budget. For example monthly and quarterly budget. It is necessary to sub divide the budget for control purpose. The management keeps a close eye on periodical budget. The variance is calculated and required adjustment is made to achieve the overall objective.

Types of Budgets

What are Budgets

The budget are basically future estimates of revenue or cost. budget is play very important rule in directing organization activity to achieve long term goals. Budget also serve the purpose of controlling the organization resources . Budgets can also be used for the purpose of performance measure of different manager and center.

Types of budgets

There are mainly the following types of budgets commonly prepared in the organization.

1. Fixed budget
2. Flexible budget
3. Zero based budget

1. Fixed Budget

A fixed budget does not change with level of activity. for example a construction manager has prepared a fixed budget for the construction of a bridge and site manager require to complete the construction work within this budget.

2. Flexible Budget

A flexible budget changes with level of activity i.e ( number of unit produced). for example for 10,000 unit the production cost was 18,000 and for 12,000 unit production cost was 20,000.

3. Zero Based Budget

Zero based budget are prepared from the scratch. This concept try to eliminate the wrong projection and encourages to prepare the budget on facts and not merely the changing the number in excel sheet. The biggest limitation of Zero based budget is time consuming.

Types of Budgets

Budgeting

The budget is basically future estimates of revenue or cost. Budget is play very important rule in directing organization activity to achieve long term goals. Budget also serves the purpose of controlling the organization resources. Budgets can also be used for the purpose of performance measure of different manager and center.

Types of budgets

There are mainly the following types of budgets commonly prepared in the organization.

1. Periodic budget
2. Rolling budget
3. Fixed budget
4. Flexible budget
5. Incremental Budgets
6. Zero based budget 

Periodic budget

The periodic budget is prepared for a period for example for one year and does not change during the period.

Rolling budget

The rolling budget is also known as continuous budget and budget is updated after a specific period of time. The concept is that budget is updating after some period of time. The advantage of this method is that budget is regularly updated and new situation incorporated in the budget, however this type of budget has little budgetary controls.

 Fixed Budget

A fixed budget does not change with level of activity. For example a construction manager has prepared a fixed budget for the construction of a bridge and site manager require completing the construction work within this budget. The fixed budget has no answer in certain situation where the budget depends on the level of activity.

Flexible budget

A flexible budget changes with level of activity.  i.e (number of unit produced). For example for 10,000 units the production cost was 18,000 and for 12,000 unit production cost was 20,000. This budget is more practical approach of budgeting because budget are prepared for operation and activities and this method give due consideration to level of activity.

Incremental Budget

The incremental budget use the last year budget as base and the incorporate inflation and other factor in that budget in that and thus a new budget is prepared.

Advantages of incremental budget

1.      This is very simple

2.      The Time is saved

Disadvantages of incremental budget

The main disadvantage of incremental budgeting is that the manager will manipulate the figure to get the desired level of performance in the next period. For example sales manager would keep the sales figure low so there would be not pressure to achive that level. Similarly the production manager would keep the wastage level high so that no one will ask him about the high level of wastage in future.

Zero Based Budgets

Zero based budgets are prepared from the scratch. This concept try to eliminate the wrong projection and encourages to prepare the budget on facts and not merely the changing the number in excel sheet. The biggest limitation of Zero based budget is time consuming.

 Advantages of Zero based budget

Justified Figures

The budget includes only the justified figures and each manager has to justify the figures before it is included in the budget. The manager has to prepare a proper case for approval.

Put Manager Responsibility

This system of responsibility is evoked by the Zero budget system. The manager take the responsibly of preparing the budget and then they are responsible to produce results in accordance with budgets.

Accuracy and Realistic

This system ensures the preparation of more realistic and accurate budget.

Disadvantages of Zero Based Budgets

Time consuming

The zero based require a detail research by the relevant manager therefore it require much time of manager to prepare the budget.

Formal

This process is very formal and it requires a lot of time and energies of manager and the manager cannot focus on their main tasks.

Pressure

This budget put extra pressure on manager for accuracy of estimates and then achievement of target set by themselves.

Attempt of actual figures

This budget tries to prepare the budget with accuracy. The basic definition that budget is a estimate is ignored.