INTRODUCTION
Budgeting control has been widely accepted as a management technique aimed at controlling an enterprise's operations in order to achieve predetermined goals. Organizations are divided into various departments based on individual needs, with specific targets set at each unit to achieve corporate goals.
The budgeting control system is based on coordinating and controlling various activities at the divisional level in order to achieve the overall corporate goal. Budgeting is as old as the world, having been used to check the king's power over taxation and to control government spending.
Budgeting control is now used as an essential tool for planning limited resources in any organization as well as the economy in general.
The Four Budget Types and Budgeting Methods
Companies typically use four types of budgets: (1) incremental, (2) activity-based, (3) value proposition, and (4) zero-based. Each of these four budgeting methods has advantages and disadvantages that will be discussed in greater detail in this guide.
Budgeting in increments
To create the current year's budget, incremental budgeting takes last year's actual figures and adds or subtracts a percentage. It is the most common type of budget because it is straightforward and simple to understand. If the primary cost drivers do not change from year to year, incremental budgeting is appropriate. However, there are some drawbacks to employing the method
Inefficiencies are likely to persist. For example, if a manager knows that he can increase his budget by 10% every year, he will simply take advantage of the opportunity to increase his budget without making any effort to cut costs or economize.
It will almost certainly result in budgetary slack. For example, a manager may overestimate the size of the budget that the team actually requires in order to appear to be always under budget.
It is also likely to ignore external activity and performance drivers. Certain input costs, for example, have experienced extremely high inflation. Incremental budgeting ignores any external factors and simply assumes that costs will rise by, say, 10% this year.
2. Budgeting by activity
Activity-based budgeting is a top-down budgeting method that determines the amount of inputs needed to support the company's targets or outputs. For example, suppose a company sets a revenue target of $100 million. The company must first determine the activities that must be carried out in order to meet the sales target, and then determine the costs of carrying out these activities.
3. Budgeting for value propositions
The budgeter considers the following questions when performing value proposition budgeting:
What is the purpose of including this amount in the budget?
Is the item valuable to customers, employees, or other stakeholders?
Is the item's worth greater than its cost? Is there another reason why the cost is justified if not?
Value proposition budgeting is really a mindset about ensuring that everything in the budget adds value to the business. Although not as precise as our final budgeting option, zero-based budgeting, value proposition budgeting aims to avoid unnecessary expenditures.
4. Budgeting from zero
Zero-based budgeting, one of the most popular budgeting methods, begins with the assumption that all department budgets are zero and must be rebuilt from scratch. Managers must be able to justify each and every expense. No expenses are automatically "approved." The goal of zero-based budgeting is to avoid any and all expenditures that are not considered absolutely necessary to the company's successful (profitable) operation. Bottom-up budgeting can be a very effective way to "shake things up."
The zero-based approach is useful when there is an urgent need for cost containment, such as when a company is undergoing financial restructuring or a major economic or market downturn that necessitates cost reduction.
Involvement Levels in the Budgeting Process
We want budget buy-in and acceptance from the entire organization, but we also want a well-defined budget that is not manipulated by people. Goal congruence and involvement are always mutually exclusive. The three themes outlined below must be considered with all types of budgets.
Budgetary constraints
Imposed budgeting is a top-down process in which executives adhere to a company goal that they set. Managers adhere to the objectives and impose budget targets for activities and costs. It can be effective if a company is in a turnaround situation and needs to meet some difficult goals with little goal congruence.
Budgeting through bargaining
Negotiated budgeting is a hybrid of top-down and bottom-up budgeting techniques. Executives may outline some of the goals they hope to achieve, but budget preparation is a shared responsibility between managers and employees. Lower-level employees' increased involvement in the budgeting process may make it easier to stick to budget targets because they feel more personally invested in the budget plan's success.
Budgeting by consensus
Participatory budgeting is a bottom-up approach in which employees recommend targets to executives from the ground up. The executives may offer some suggestions, but they largely accept the recommendations of department managers and other employees (within reason, of course). Operations are treated as autonomous subsidiaries with significant budgetary autonomy.
Conclusion
Budgeting systems can help management with planning, coordination, inter-relationship activities, and performance evaluation. Planning is widely used in determining objectives or setting targets, formulating policies, strategies, and alternative priorities. It entails conducting a critical examination and analysis of the source and application of funds.
The firm can reduce costs and improve service quality by implementing proper budgetary control planning based on its budgetary allocations. This helps to reduce costs while also increasing goal achievement and thus organizational effectiveness.