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In this dynamic world, it is imperative for enterprises to prepare budgets as part of strategic planning to remain competitive. A budget is an operational plan for a specific period and is usually prepared within a period of one year (Taschner and Charifzadeh, 2016 Lee, Johnson and Joyce, 2020). A budget is normally expressed in monetary terms in the form of an income statement or statement of financial position.
There are six different budgeting methodologies that may be used during the preparation of budgets. According to Nazarova, Shtiller, Selezneva, and Kohut (2016), budgeting methodologies that are properly employed enhance organizational performance.
According to Reka, Stefan, and Daniel (2014), successful organisations embrace well-coordinated budgeting methodologies, such as Traditional Budgeting, Zero Based Budgeting, Flexible Budgeting, Incremental Budgeting, Continuous Rolling Budgeting, and Activity Based Budgeting.
It is from this background that this article focuses on the purpose of budgeting, approaches to budgeting and budgeting methodologies. The following are the purposes of budgeting which assist companies to remain competitive in this turbulent environment. The following section discusses the purpose of budgeting.
Purpose of budgeting
- An entity uses the budget to forecast income and expenditure.
- An entity uses the budget as a tool for decision-making.
- An entity monitors its performance through the budgeting process.
- An entity uses the budget for strategic planning.
- The budgeting process assists the management of enterprises to be responsible and accountable for their respective areas.
- An entity uses budgets to enhance coordination and cooperation among its senior management.
The following section focuses on the approaches to budgeting.
Approaches to budgeting
There are two approaches to budgeting as follows:
This is whereby organizational budgets/plans are driven by top – management who are perceived to be most knowledgeable about the factors affecting an enterprise. The top-down approach is characterized by inflexibility, bureaucracy, overall control, and imposed processes which results in low moral as members of staff feel that their opinion does not matter.
This is whereby organizational budgets/plans are coordinated from each unit and then escalated to the senior management. This approach involves the engagement of all staff members in budget planning. The staff members feel that they are empowered hence their involvement matters. The bottom-up approach is characterized by flexibility, agility, collaboration, and team-driven processes which result in a high level of motivation, that eventually leads to high productivity being achieved.
Traditional budgeting is a method that relies on the past budgets and financial history of an organisation. This method provides a link between the budget and strategy through planning, coordinating, controlling, and performance management.
The traditional budgeting increases the power of the top management whilst limiting the empowerment amongst the lower managers. Furthermore, traditional budgeting is inclined to incremental budget as it relies heavily on historical information.
Zero – Based Budgeting:
The Zero-based budgeting method focuses on determining outcomes that are required by management to develop expenditure packages for an entity. The Zero-Based Budgeting method combines various outcome expenditure packages from which a budget is derived which is based on the result of a specific set of outcomes from the entire business.
The Zero-Based Budgeting method is most useful in service-level entities such as Governments, where the provision of services is of paramount importance.
Flexible budgeting is a method that allows an entity to enter different sales levels that will then be adjusted as per planned expenditure levels and then match the sales levels that will have been previously entered. The flexible budgeting method is useful when sales levels are being estimated.
Incremental budgeting method is more challenging to prepare than static budgeting methods, however, it tends to yield a budget that is reasonable compared to the actual results. The incremental budgeting method is one of the strategies used to update budgets as it assumes that what has happened in the past can be rolled over into the future through incremental adjustments.
The incremental budgeting method results in simplified budget updates in small incremental adjustments.
Continuous Rolling Budgeting
A continuous rolling budgeting method requires that a new budget period be added as soon as the most recent period has been completed. The continuous rolling budgeting method always extends uniformity into future forecasting. However, the continuous rolling budgeting method requires a considerable amount of budgeting work in every accounting period to formulate the next incremental update.
Activity Based Budgeting:
The activity Based Budgeting method is prepared based on the resource consumption and related costs to perform the budgeted activities. The Activity-Based Budgeting method uses activities that drive the costs. A budgeted level of activity for each of the drivers is determined based on a budgeted level of production. In addition, the budgeting is based on budgeted activity levels. In an activity-based budget method, there is a clear relationship between resource consumption and output. Furthermore, an activity-based budget method brings information about opportunities for cost reductions and elimination of wasteful activities.
It matters to embrace any of the budgeting methodologies as explained above. It is imperative for the entity to embrace any of the above-stated budgeting methodologies to remain competitive in this dynamic business environment.
It is important to embrace the budgeting methodologies in this dynamic business environment as the entity will remain competitive. It is critical for each company to select any of the methodologies based on its organisational culture, in relation to the goods and services being offered.
In conclusion, this article indicates that the preparation of budgets enhances organisational performance which leads to a bigger market share and results in profitability in the long run.