Basic Budgeting Systems
Basic Budgeting Systems
The static budgeting system employs the traditional budgeting approach because it uses historical budgets that existed prior to the budgeting period to inform the preparation of current budgets. Therefore, the static budgeting system remains unchanged during the budget period regardless of the prevailing organizational circumstances (Henttu-Aho, 2016). The budget estimates are based on the assumption that no changes occurred between the previous and current budget periods. As such, organizational tasks and activities follow the resources allocated by the management (Radu & Giju, 2015).
The static budgeting system is easy to formulate and administer because it relies on information already available prior to the budgeting period and therefore does not require continuous updating for the current accounting period. In addition, it offers deep insights into the costs and profits of an organization through the performance of a variance analysis. This enables the overestimation or underestimation of revenues and expenses, which enables improvement of organizational objectives in future. It also enables improved control of costs and smart decision-making (Radu & Giju, 2015).
The system lacks flexibility, which hinders the allocation of additional resources, and therefore is unfavorable for organizations with unpredictable sales volumes, revenues and costs (Henttu-Aho, 2016). Besides, the system is unfavorable for organizations that experience large annual fluctuations in the budgetary items, and is therefore not suitable for firms that are new or those that operate in volatile and unpredictable environments (Radu & Giju, 2015).
The zero-base budgeting system is premised on the justification of all budgetary expenditures by assuming a zero expenditure base line (Shim, Siegel & Shim, 2011). Assuming that an organization has the basic resources to undertake and sustain its core functions, the system requires the reevaluation of every line item in actual cash flow statements and a justification of all organizational expenditures in accordance with the institutional economic theory that focuses on efficiency, unlike traditional budgeting that relies on historical information (De Waal, Hermkens-Janssen & van de Ven, 2011). As such, resources follow established organizational tasks and activities without regard for the existing expenditure structure.
The zero-base budgeting system enables an organization to redefine, reprioritize and refocus its mission to better link organizational expenditures to activities (Shim, Siegel & Shim, 2011). As such, the manager is forced to conduct reviews continuously to identify redundancies and eliminate the activities that are not critical to the firm. This stimulates a participatory budgeting process among the management as they clarify to corporate mission and seek alternatives to undertake organizational activities incur lower costs while delivering better organizational performance (Schick, 2014). Moreover, artificially inflated budgets that are above the cost baseline are easy to identify, which improves resource allocation.
This system is disadvantaged by the requirement for meticulous investigation and documenting of the organizational activities, which is time consuming and likely to yield regular significant changes in the organization (Shim, Siegel & Shim, 2011). The high managerial involvement may cause the budgeting process to be bureaucratic and require training in the budgeting process (Lee, Johnson & Joyce, 2013). In addition, business areas that yield intangible results are difficult to justify while gamesmanship in the organization can be eroded as managers attempt to skew budgets sustain activities under their jurisdiction. Moreover, the organization could lose its competitive advantage as it has to continuously match its budgeting speed with emerging business conditions.
The flexible budgeting system has the budget varying according to the needs of the organization, which are likely to change from time to time. It is a pragmatic and activity-based budgeting approach that accommodates the varying expenditures from the dynamic actual activity levels experienced in an organization (De Waal, Hermkens-Janssen & van de Ven, 2011).
Firstly, the flexible budgeting model can be used to measure the performance of the organization because the budget structure is closely related to the activity level in the organization. More specifically, the budget is closely aligned to the expectations of the organization in its various activity levels and therefore can be used to evaluate the performance of the managers responsible for the various activities in the organization (Walther & Skousen, 2014). Secondly, the flexible budgeting system is applicable in organizational environment where cost of activities is variable. This is particularly appropriate in business organizations whose levels of activities are closely aligned with the costs, such as those in the retail industry. For instance, revenues are linked directly to the cost of goods and services in the retail environment and therefore, overheads can be treated separately as a fixed cost. Thirdly, the flexible budgeting system enhances the efficiency of budgeting because it accommodates budgetary updates along an ongoing budgeting process (Cardoş, 2014). For instance, in organizations where expenses are pegged on ongoing organizational activities and revenues, such expenses can be approved as proportions of the revenues or other measures of organizational activity. Therefore, the expenditure alters as the budgeting process is finalized and activity and revenue information is updated (Radu & Giju, 2015). Using a budgeting formula enables expenditures in the budget to be updated upon consideration of information related to activity measures and revenues, and the managers give their approvals. Altogether, it resolves many of the challenges experienced in the static budgeting system (Cardoş, 2014).
Firstly, the flexible budgeting system does not measure revenues variances since the budgeted revenues are updated to match the actual revenues. Likewise, the budgeted and actual expenses are similar because they are based on the same revenue figures. As such, it is difficult to determine how the actual revenues and expenditure compare with the organizational expectations. Secondly, the budgeting process is lengthy because of the complex formulations, which are difficult to formulate and administer (Walther & Skousen, 2014). The complexity emanates from the absence of all the cost information at the beginning of the budgeting process and the fluctuating variability is many of the organizational costs, which makes it difficult to identify the fixed cost in the budget formula. As such, the budgeting and financial reporting processes are delayed as information related to revenue and other measures of activity continue to be updates until the end of the fiscal period (Cardoş, 2014). Thirdly, the budgeting system has limited organizational applicability because few firms have very few variable costs to influence their expenditures significantly. Notably, organizations tend to have large fixed overheads that do not vary with activity type, and therefore, the construction of complex budgeting formulae is not justifiable (Radu & Giju, 2015).
The Rolling Budget
The rolling budget system is an incremental budgeting approach that updates the budget of an organization regularly by extending the accounting period by a month or a quarter. As such, it is a dynamic rather that a static process because the budget period is continuously added rather than fixed (Zeller & Metzger, 2013).
The rolling budget system ensures that that there is existing annual budget in the organization at any given time. This not only improves the accuracy of planning and controlling but also reduces budgetary uncertainties by ensuring that the organization has a short-term plan. This enables the organization to respond better to the changes in the business environment besides helping it to monitor sales, revenues and profitability more closely. It also helps organizations take advantage of identified opportunities, which not only enhances the organizational versatility but also helps maintain its competitive advantage and improve performance (Sandalgaard & Bukh, 2014).
This system is time consuming and personnel intensive because budget updates have to be undertaken regularly alongside regular revision of budget assumptions. As such, the budgeting process may demoralize employees due to the regular changing of budgetary targets and the much time they spend in its preparation and updating. Also, the control of actual results may be compromised by increased focus on budgeting (De Waal, Hermkens-Janssen & van de Ven, 2011). Moreover, the budgets prior to the incremental period are used unrevised while only those in the additional period are updated, which introduces inaccuracies in the budget of the entire period.
Best budgeting system for the organization
The rolling budget system would suit my previous organization best. The organization is in the retail industry that experiences high competitiveness, and volatile and unpredictable business conditions and therefore unpredictable expenditures, sales volumes and revenues. Therefore, to remain competitive yet flexible, the firm should use the rolling budget system because it provides a short-term plan, which makes the company more responsive to the rapidly-changing market and industry forces (Becker et al., 2016). Moreover, under the fiercely competitive conditions in the retail sector, the firm needs to extract as much value from its budget dollar as possible, and as such, the return on investment should be guaranteed through the smart use of market intelligence and business activity information (Cardoş, 2014). The firm collects volumes of information relating to customers and merchandise sales, which fluctuate significantly in short periods. Therefore, having the rolling budgeting system that continually updates expenditures, and changing budget targets and forecasts using the information available at the company would guarantee that the company remains responsive to its customers’ needs and preferences alongside the rapidly changing retail environment in a liberalized market economy (Sandalgaard & Bukh, 2014; Zeller & Metzger, 2013).
Becker, S. D., Mahlendorf, M. D., Schäffer, U., & Thaten, M. (2016). Budgeting in times of economic crisis. Contemporary Accounting Research, 33(4), 1489-1517.
Cardoş, I. R. (2014). New trends in budgeting–a literature review. SEA–Practical Application of Science, 2(04), 483-489.
De Waal, A., Hermkens-Janssen, M., & van de Ven, A. (2011). The evolutionary adoption framework: explaining the budgeting paradox. Journal of Accounting & Organizational Change, 7(4), 316-336.
Henttu-Aho, T. (2016). Enabling characteristics of new budgeting practice and the role of controller. Qualitative Research in Accounting & Management, 13(1), 31-56.
Lee, R. D., Johnson, R. W., & Joyce, P. G. (2013). Public budgeting systems. Burlington, MA: Jones & Bartlett Publishers.
Radu, M., & Giju, G. C. (2015). The Flexible Budget–Basic Tool Of The Management Control In The Economic Entities. Scientific Bulletin-Economic Sciences, 14(1), 3-10.
Sandalgaard, N., & Bukh, P. N. (2014). Beyond budgeting and change: a case study. Journal of Accounting & Organizational Change, 10(3), 409-423.
Schick, A. (2014). The metamorphoses of performance budgeting. OECD Journal on Budgeting, 13(2), 49-79.
Shim, J. K., Siegel, J. G., & Shim, A. I. (2011). Budgeting basics and beyond (Vol. 574). Hoboken, NJ: John Wiley & Sons.
Walther, L. M., & Skousen, C. J. (2014). Budgeting: Planning for Success. Bookboon.
Zeller, T. L., & Metzger, L. M. (2013). Good Bye Traditional Budgeting, Hello Rolling Forecast: Has The Time Come? American Journal of Business Education, 6(3), 299-310.