Budgeting Techniques

Let’s consider the various types of budgets we can adopt for a business. They are:

• Fixed budget
• Flexible budget
• Zero-based budget
• Rolling budget
• Static budget

The Fixed Budget

As the name suggests, a fixed budget is for a fixed period and for a fixed amount of income and expenditure. Normally given for a year at a time, the fixed budget sets out the allowed total expenditure by month, quarter, or whatever.

This is then compared in detail to the actual expenditure. Monthly variances and cumulative variances are listed. A somewhat rigid system normally doesn’t take into account changes in inactivity or other factors affecting the financial results of the business.

The Flexible Budget

Using this system recognises the relationship between activity, fixed costs and variable costs. Accordingly, the budget, or at least certain items within the budget, is increased or decreased to take into account the increase or decrease in inactivity. For example: If a company’s sales increase by 8%, then the knock-on effect on distribution – transport, warehousing and packaging – is calculated pro-rata or to an agreed formula so that the departmental budgets are increased to finance the extra workload.

The advantage of a flexible budget is that the manager can explore more accurately the underlying reasons for the variations from original budgeted expectations.

Zero-Based Budget (Activity-Based)

These are mostly used when a company is in a financial fix or after a company has been taken over or merged with another company. The current budgets are suspended and all budget holders are asked to question and justify any expenditure not directly related to the core activities of the business.

Core activities are activities within the business that are directly linked to the main sources of money coming into the business.

The idea is to reduce expenditure for the master budget so that senior management can establish the minimum requirements to run the company. This system purposely ignores the history that may or may not contain any false theories and so starts from scratch.

Rolling Budget

This is not really a budgetary system in that it is more a method of updating the current budget on a continuous basis. The current budget maybe for a 12-month period. It is considered active. Each month or quarter the budget is projected for a further twelve or maybe even an 18-month period, depending on what management feel is appropriate. So, if the budget is split into quarters, then as quarter one is finished for that first year, so quarter one will be calculated for the following year. There is an advantage to rolling budgets and that is that they get away from the fixed budget type of thinking. This means that management does not and cannot take their eyes off the ball.

Static Budgets

This variation on the traditional budget addresses the problem of budget rigidity in a somewhat different manner. The traditional model, a static budget, presents one set of forecasted numbers for a given time period and is not changed during the life of the budget.