Budget methods
- 1. Budget methods 1
- 2. Main contents Incremental budgeting vs. Zero-based budgeting Top down budgeting vs. bottom up budgeting 2
- 3. Incremental budgeting and Zero-based budgeting 3
- 4. Incremental budgeting Incremental budgeting definition: Prepared based on the current periods budget with some added amounts regarding inflation or planned increases in sales and costs (Ann, 2011) Advantages: Simple to prepare and understand Consistent basis Better co-ordination between budgets Disadvantages: Totally ignore the impact of changes No incentive in development and innovation Encourages spending up to the budget This approach is not recommended as it fails to take into 4 account changing circumstances
- 5. Zero-based budgeting In the mid-20th century, money got tighter and problems associated with incremental budgeting began to give rise to a feeling that changes were needed. By the 1960, ZBB emerged in the concept. ZBB definition It starts each budget period from a base of zero, with no reference to the prior period (Anon, 2010). Every department function has to justify the resources used for their relevant activities. Unless the activity is justified, there will be no resource allocation for it. 5
- 6. Zero-based budgeting Stages of ZBB Step 1: Activities are identified by the managers. These activities are then described in decision packages. Step 2: Management will then rank all the packages in the order of decreasing benefits to the organisation Step 3: Resources in the budget are then allocated on order of priority up to the spending level. 6
- 7. Zero-based budgeting Advantages Efficient allocation of resources Drives managers to find cost reduction methods Identifies and eliminates wasteful activities Disadvantages Very complex Time and manpower consuming Necessary to train employees, especially managers In a relatively large corporation, the amount of information might be too excessive to go through all. Compressing the information might take out critical details Can result in internal conflicts between departments over budget allocation. 7
- 8. Consideration Since all the costs are required to be justified, it seems inappropriate to use ZBB for the whole budgeting process. One way of overcoming this drawback is to use this method selectively. 8
- 9. Bottom-up budgeting and top-down budgeting 9
- 10. Top-down budgeting (Imposed budgeting) Definition: Top-Down Budgeting is the term given to a budgeting process based on estimating the cost of higher level tasks first and using these estimates to constrain the estimates for lower level tasks (Anon, 2010) Advantages: Takes less time Promotes upper-level commitment Can address the objectives of the organisation Disadvantages: The decision made by the upper managers might be inaccurate due to limited knowledge, which in turn will result in insufficient budget for the department and cause potential for underperformance Lower morale of subordinates that they are not involved 10
- 11. Bottom-up budgeting (Participated budgeting) Definition: Bottom-up budgeting begins with identifying all the constituent tasks that are involved in implementing a project and working out the resources and funding required by each Advantages: Clear and detailed information Get involved all employees Higher level of morale and motivation Disadvantages: Top management has little influence over the budgeting process Some essential areas might be overlooked by the lower-level managers Some parts in the budget might be exaggerated 11 Time consuming and costly
- 12. Consideration In general, top-down budgeting is used more often. Senior managers perceive bottom-up as risky and unreliable A mix of both methods can be useful in some circumstances. If there is any discrepancies between the numbers, adjustments will be made until the two versions meet. 12
- 13. Thank you for listening! 13