Types of Budgets
There are many types of budgets. They may be classified into several basic types. Most organizations develop and make use of three different types of budgets: operating budgets, capital expenditures budgets, and financial budgets
- Operating Budgets
An operating budget is a statement that presents the financial plan for each responsibility centre during the budget period and reflects operating activities involving revenues and expenses. The most common types of operating budgets are expense, revenue, and profit budgets.
(i) Expense Budget
An expense budget is an operating budget that documents expected expenses during the budget period. Three different kinds of expenses normally are evaluated in the expense budget - fixed, variable and discretionary (Discretionary expenses - costs that depend on managerial judgment because they cannot be determined with certainty, for example: legal fees, accounting fees and R&D expenses).
(ii) Revenue Budget
A revenue budget identifies the revenues required by the organization. It is a budget that projects future sales.
(iii) Profit Budget
A profit budget combines both expense and revenue budgets into one statement to show gross and net profits. Profit budgets are used to make final resource allocation, check on the adequacy of expense budgets relative to anticipated revenues, control activities across units, and assign responsibility to managers for their shares of the organization's financial performance
- Financial Budgets
Financial Budgets outline how an organization is going to acquire its cash and how it intends to use the cash. Three important financial budgets are the cash budget, capital expenditure budget and the balance sheet budget.
Cash budget Cash budgets are forecasts of how much cash the organization has on hand and how much it will need to meet expenses. The cash budget helps managers determine whether they will have adequate amounts of cash to handle required disbursements when necessary, when there will be excess cash that needs to be invested, and when cash flows deviate from budgeted amounts. Capital Expenditure Budget Capital Expenditure Budgets. Investment in property, buildings and major equipment are called capital expenditure. Such capital expenditure budgets allow management to forecast capital requirements, to on top of important capital projects, and to ensure the adequate cash is available to meet these expenditures as they come due. The balance sheet budget The balance sheet budget plans the amount of assets and liabilities for the end of the time period under considerations. A balance sheet budget is also known as a pro forma (projected) balance sheet. Analysis of the balance sheet budget may suggest problems or opportunities that will require managers to alter some of the other budgets
- Variable Budgets
Because of the dangers arising from inflexibility in budgets and because of maximum flexibility consistent with efficiency underlines good planning, attention has been increasingly given to variable or flexible budgets. To deal with this difficulty, many managers resort to a variable budget.
Whereas fixed budgeted express that individual costs should be at one specified volume, variable budgets are cost schedules that show how each cost should vary as the level of activity or output varies.
There are three types of costs that must be considered when variable budgets are being developed: fixed, variable, and semi-variable costs. The problem in devising variable budgets is that cost variability is often difficult to determine and that they are often quite expensive to prepare.
- Zero-Base Budgets
The conventional budgeting process does have one major disadvantage. Managers tend to prepare new budget requests by adding an incremental amount to their previous year's budget requests, rather than re-evaluating the need for things already included.
Zero-base budgeting (ZBB), in contrast, enables the organization to look at its activities and priorities a fresh. Zero-base budgeting assumes that the previous year's budget is not a valid base from which to work. It forces department managers to thoroughly examine their operations and justify their departments activities based on their direct to the achievement of organizational goals.
The U.S. Department of Agriculture was the first to use zero-based budgeting in 1960s. ZBB was adopted by Texas Instruments in 1970 and by many government and business corporations during the 1970s and 1980s.
The specific steps used in zero-based budgeting are as follows:
1.Break down each of an organization's activities into "decisions packages". The decision package includes written statements of the department's objectives, activities, costs, and benefits; alternative ways of achieving objectives; plus the consequences expected if the activity is not approved. Managers then assign a rank order to the activities in their department for the coming year.
2.Evaluate the various activities and rank them in of decreasing benefits to the organization. Rankings for all organizational activities are reviewed and selecting by top managers.
3.Allocate resources. Budget resources are distributed according to the activities rated as essential to meeting organizational goals. Some departments may receive large budgets and others nothing at all. The principal advantage of this technique is the fact that it forces managers to plan each program package afresh. However, it demands more time and energy than conventional budgeting.