Types of budgets, Definition, and Classification
It is necessary to be familiar with the various types of budgets to understand the whole picture and how these budgets interrelate. The types of budgets include master, operating (for income statement items comprised of revenue and expenses), financial (for balance sheet items), cash, static (fixed), flexible, capital expenditure (facilities), and program (appropriations for specific activities such as research and development, and advertising). Below we have briefly explained these budgets.
A master budget is an overall financial and operating plan for a forthcoming calendar or fiscal year. it is usually prepared annually or quarterly. So A master budget is really a number of sub-budgets tied together to summarize the planned activities of the business. The format of the master budget depends on the size and nature of the business.
Operating and Financial Budgets
The operating budget deals with the costs for merchandise or services produced. So The financial budget examines the expected assets, liabilities, and stockholders’ equity of the business. You will need to know the financial health of the company.
The cash budget is for cash planning and control. It presents expected cash inflow and outflow for a designated time period. So The cash budget helps management keep cash balances in reasonable relationship to its needs and aids in avoiding idle cash and possible cash shortages.
The cash budget typically consists of four major sections:
- Receipts section, which is the beginning cash balance, cash collections from customers, and other receipts
- Disbursement section, comprised of all cash payments made by purpose
- Cash surplus or deficit section, showing the difference between cash receipts and cash payments
- Financing section, providing a detailed account of the borrowings and repayments expected during the period
Static (Fixed) Budget
The static (fixed) budget is budgeted figures at the expected capacity level. Allowances are set forth for specific purposes with monetary limitations. So We use it when the company is relatively stable. Thus, we have usually referred stability to sales. So The problem with a static budget is that it lacks the flexibility to adjust to unpredictable changes. In industry, fixed budgets are appropriate for those departments whose workload does not have a direct current relationship to sales, production, or some other volume determinant related to the department’s operations.
We define division work through management decisions, not sales volumes. Most administrative, general marketing and even manufacturing management departments are in this category. So Fixed appropriations for specific projects or programs not necessarily completed in the fiscal period also become fixed budgets to the extent that they will be expended during the year. So Examples are appropriations for capital expenditures, major repair projects, and specific advertising or promotional programs.
Flexible (Expense) Budget
A flexible budget (expenses) is the one that companies use the most. It allows for variability in the business and for unexpected changes. It is dynamic in nature rather than static. So Flexible budgets adjust budget allowances to the actual activity.
Flexible budgets are effective when volumes vary within a relatively narrow range. They are easy to prepare with computerized spreadsheets such as Excel.
The four basic steps in preparing a flexible (expense) budget are:
- Determine the relevant range over which activity is expected to fluctuate during the coming period.
- Analyze costs that will be incurred over the relevant range in terms of determining cost behavior patterns (variable, fixed, or mixed).
- Separate costs by behavior, determining the formula for variable and mixed costs.
- Using the formula for the variable portion of the costs, prepare a budget showing what costs will be incurred at various points throughout the relevant range.
Due to uncertainties inherent in planning, three forecasts may be projected: one at an optimistic level, one at a pessimistic or extremely conservative level, and one at a balanced, in-between level.
Capital Expenditure Budget
The capital expenditure budget is a listing of important long-term projects to be undertaken and capital (fixed assets such as plant and equipment) to be acquired. We calculate the estimated cost of the project and the timing of capital expenditures as well as how to fund the capital assets. The budget period usually ranges from 3 to 10 years. We do not create a capital projects committee, usually separate from the budget committee, except for the purposes of capital budgeting.
The capital expenditures budget often classifies individual projects by objective, as for:
- Expansion and enhancement of existing product lines
- Cost reduction and replacement
- Development of new products
- Health and safety expenditures
The lack of funds may prevent attractive potential projects from being approved.
Approval of a capital project typically means approval of the project in principle. However, final approval is not automatic. In order for us to obtain final approval, we are preparing a special license application for the project, explaining the proposal in more detail. Depending on the nature and size of the dollar, we may approve licensing requests at different administrative levels.
We determine to program for the amount we will fund and the amount. A common application of program budgets is to product lines. We allocate resources to a specific goal with a review of existing and new programs.
Some suitable program activities include research and development, marketing, training, preventive maintenance, engineering, and public relations.
We usually allocate the funds on a cost-effective basis. In budget negotiations, we explain and justify the proposed budget numbers. The program budget typically cannot be used for control purposes because the costs shown cannot ordinarily be related to the responsibilities of specific individuals.
Depending on needs and convenience, budgets can be classified as incremental, add-on, supplemental, bracket, stretch, strategic, activity-based, target, and/or continuous.
Incremental budgeting looks at the increase in the budget in terms of dollars or percentages without considering the whole accumulated body of the budget. There are also self-contained, self-justified increments of projects. Each one specifies resource utilization and expected benefits. We can separate the project from one or more additional. Here, we need additional increases to complete the project. We assign manpower and resources to each increase.
The additional budget is the budget in which we check budgets for prior years and adjust them according to current information, such as inflation and staff growth. We tend to budget to meet the new requirements. With the add-on, there is no incentive for efficiency, but competition forces one to look for new, better ways of doing things. For example, Konica Imaging U.S.A. has combined add-on with the zero-based review.
Supplemental budgets provide additional funding for an area not included in the regular budget.
Sagittarius budget is an emergency plan in which we estimate costs at levels above and below the base amount. Then we expect sales to these levels. The purpose of this method is that if we do not achieve the core budget and the resulting sales forecasts, the arc budget provides the management with a sense of the impact of profits and an emergency expenditure plan. An emergency budget may be appropriate when there are negative risks that we must plan for, such as a sharp drop in revenue.
We consider the stretched budget to be an optimistic budget. Usually, we only limit sales and marketing expectations that are higher than estimates. We rarely apply it to expenses. We may inform stretching targets informally without questioning operating units. Alternatively, stretch targets may be official estimates for sales/marketing personnel. We may estimate expenditures based on the standard budget sales goal.
Strategic budgeting integrates strategic planning and budgeting control. It is effective under conditions of uncertainty and instability.
Activity-based budgeting budgets costs for individual activities.
A target budget is a plan in which categories of major expenditures are matched to company goals. The emphasis is on formulating methods of project funding to move the company forward. There must be strict justification for large dollars and special project requests.
The ongoing (renewable) budget is the budget that we regularly review (continuous). Typically, a company extends such a budget for another month or quarter in accordance with new data as the current month or quarter ends. For example, if the budget is for 12 months, a budget for the next 12 months will be available continuously as each month ends.