03 - Approaches to budgeting.

Purposes of budget planning

Planning. | Authorisation. | Delegation. | Evaluation. | Motivation. | Communication. | Co-ordination. | Control.

Top-down budget is...

A budget that is IMPOSED on the budget holder by senior management.

Advantages of top-down budget:

Slack avoiding. | High-level management retain control. | Inexperience managers bad decisions avoiding. | Dysfunctional behaviour avoiding. | Occasionally quicker.

Bottom-up budget involves...

divisional managers participating in the setting of the budgets.

Advantages of bottom-up budgets:

Time of senior management released. | Local knowledge using. | Understanding of divisional managers increased. | Motivation improved.

Fixed budget definition:

When a budget is prepared for single level of activity.

Flexible budget definition:

Prepared with the cost behaviour of all elements known and classified as either fixed of variable. The budget may be flexed to the actual level of activity.

Rolling budget definition:

Kept continually up to date by adding another period when the earliest period has expired.

Incremental budget definition:

Starts with previous period's budget or actual results and adds or subtracts an INCREMENTAL AMOUNT.

Activity-based budgeting characteristics (ABB):

Uses the principles of ABC | to estimate the firm's future demand for RESOURCES so can help the firm to acquire these resources more efficiently.

Steps involved in Activity-Based Budgeting

1. Estimate the production and sales volumes. 2. Estimate the demand for activities. 3. Determine the types of resources required.

Advantages of ABC:

Recognises that complexity and diversity result in overheads not all driven by activity level. | More accurate cost per unit. | Understanding of what drives costs resulting in better: - pricing - cost control - decision making.

Disadvantages of ABC:

Time and cost. | Advantages limited if OVERHEADS minimal or mainly driven by level of production. | Customers may not tolerate 3 changes*. | Advantages limited if activity costs already well controlled.

Activity-based management (ABM) is:

Method of evaluating ACTIVITIES | that a business performs using ABC to carry out | a value chain analysis or BPR | to improve strategic and operational decisions in an organisation.

Zero-based Budgeting definition:

A budgeting that requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time. Without approval, the budget allowance is zero.

Steps in ZBB:

1. Managers specify for their responsibility centres those activities that can be individually evaluated. 2. Describe each of the individual activities in a decision package*. 3. Evaluate and rank each package**. 4. Allocate resources to various packages.

Advantaged of ZBB:

Obsolete or inefficient operations can be identified and ended. | Business environment changes responding. | Resources allocated economically. | Understanding a cost-behaviour | Staff involvement at all levels increased.

Disadvantages of ZBB:

Management skills needed. | Activities difficult to compare. | Judgemental nature of packages rankings. | Short-termism. | Time and cost. | Enormous demotivation due to time spent. | Rigidity of budgeting process danger.

Rolling budgets advantages:

Serious treatment of budgeting process improved. | Information of PM is better. | Accurateness is improved. | Relevance much better by the end of the traditional budgeting period.

Rolling budgets disadvantages.

Demotivating as the targets are changing regularly. | Last budget 'Plus or minus a bit' danger. | Actual results weaker controlled.* | Time-consuming.

Variances types:

Planning | and Operational.

Planning variance definition:

The difference between the original an the revised budget (uncontrollable by line manager).

Operational variance definition:

The difference between the revised standard and the actual performance (controllable by line manager).

Operational ABM is about:

“doing things right”

Strategic ABM is about:

“doing the right things”