What is Budgeting? A budget is an integrated financial plan for a designated period, usually one year to five years. It will also include projected revenues and volumes, expenses, capital assets, liabilities and expenditures, total resources, costs and allowances, and liquid cash inflow. To simplify things, budgeting is the process of forecasting and managing resources for the accomplishment of financial objectives in a realistic and balanced way.
There are several types of budgeting methods available. Most budgets are designed and prepared by financial experts with at least some background in accounting principles. For most organizations, budget preparation is done by a single person, usually a member of the executive team. However, small businesses can also prepare detailed annual, individual budgets.
The traditional budgeting technique, detailed accounting, is based on the principle that each transaction should be identified, measured, aggregated, and reflected in the current year financial records. By doing this, the manager or the staff can determine which expenditures are essential, those that are unnecessary, and those that could be reallocated to better achieve the budget’s purpose. In other words, the manager is determining where money is being spent in support of the objectives and programs of the organization.
In addition, detailed budgeting relies on timely collection and analysis of financial information, which requires information systems expertise. In short, the whole process is time-consuming, requiring significant man-power in both personnel and data entry. Also, even if all the information needed is collected and analyzed in the current year, there is still a good chance that the information will be outdated before the next budget is presented. If not, the manager will have to start the budget process from the beginning of the next fiscal year, extending right up to the time when the next budget is made.
On the other hand, the activity-based budgeting method requires very little data collection and no specialized knowledge. The only prerequisite is that the manager is able to determine the financial activities that support the organization’s goals and programs. Unlike the traditional budgeting concept, activity-based budgets require no memory bank, no ongoing maintenance, as everything is accounted for at the end of the current year. Also, since all financial transactions are accounted for at the end of the current year, there is no reason to hold back information, which might be necessary in the next budget preparation. This provides the opportunity to develop a comprehensive, integrated, and forward-looking activity-based budget.
Both traditional and activity-based budgeting methods have their advantages and disadvantages. Traditional budgets are based on accounting and are very detailed and require a great amount of human effort. However, these budgets are very time-consuming to prepare and require the manager’s full attention. Also, the accuracy of these traditional budgeting methods are suspect at best and can result in biased information, which makes them less effective than they should be.
On the other hand, activity-based budgeting techniques such as the zero-based budgeting method are based on a mathematical model. It is built on information supplied by the manager and it is more accurate and more effective than traditional budgets. It has the potential to provide a significant amount of insight into organizational issues and problems, but the main drawback is that it can take a long time to build up. With this technique, budget information is collected once and is usually updated every year. A detailed understanding of organizational problems can be obtained much more quickly than with a traditional based budgeting technique. Also, using activity-based budgeting techniques provides the manager with a good understanding of the organization’s internal processes and the resources it uses to implement its activities.
While both types of budgeting methods have their value, the data collected using activity-based techniques are more accurate and more timely. This allows for more detailed analysis and a more critical examination of organizational problems. As a result, the manager can make more informed decisions regarding various aspects of the business, allowing him or her to create a more successful strategy for the future. The manager can also make better use of the previous year’s data when formulating a new budget, making things easier to understand and improve in the future.