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Classification of Budget

Classification of Budget

Different types of budgets have been developed keeping in view the different purposes they serve. Some of the important classifications of the budgets are discussed below.

A. Classification According to Time

Based on the time factor, budgets are broadly classified in the following three types.

(i)                 Long term Budgets. The budgets are prepared to show the long term planning of the organisation. This budget is prepared normally for a period of 5 to 10 years. Example : Capital expenditure budget, research and development, long term finances etc.

(ii)               Short term Budgets. Short term budgets are those which have to be prepared for a period of one or two years. Example : Cash Budget, Material Budget etc.

(iii)             Current Budget. Current budget is one which has to be prepared for a very short period say a month or a quarter year and is related to the current conditions.

B. Classification According to Function

A functional budget is a budget which relates to any of the functions of an organisation. The following are the functional budgets commonly used.

(i)                 Sales Budget. Sales budget is a forecast of total sales (volume) during the budget period. It may contain the information regarding the sales, month wise, product wise, and area wise. This budget is prepared by the sales manager.

(ii)               Production Budget. Production budget is prepared by the production manager. Its preparation depends upon the sales budget. The objective of this budget is to determine the quantity of production for a budgeted period. In other words, it is a quantity of units to be produced during a budget period.

Production units may be calculated in the following way: budgeted sales+ desired closing stock – opening stock.

(iii) Materials Budget. Material procurement budget is an estimate of quantities of raw materials to be purchased for production during the budget period. It helps the organisation to formulate effective purpose policy of raw materials. Materials budget should be prepared normally taking into account the following factors i.e., availability of finance, storage facilities, price trends in the markets.

(iv) Labour Budget. Labour budget is a budget which is prepared by the personnel department of the organisation. It shows the total hours required to complete the production target. And also it shows the cost incurred for the labour used for the production.

(v) Factory Overhead Budget. This budget indicates the estimated costs of indirect materials, indirect labour and indirect factory expenses incurred during the budget period. This budget is classified into fixed, variable and semi-variable.

(vi) Administrative Expenses Budget. In order to estimate the amount required to meet the administrative and operational activities of the organisation, the administrative expenses budget is prepared. This budget will provide proper guidance and estimation for the expenses incurred in the budget period.

(vii) Selling and Distribution Overhead Budget. This budget is prepared by the sales manager of each territory. It indicates an estimate of administrative expenses to be incurred in the budget period. Preparation of selling and distribution overhead budget depends upon the sales budget.

(viii) Capital Expenditure Budget. Capital expenditure budget is a long term planning for the proposed capital outlay and its financing. Capital expenditure is an expenditure which has to be incurred for the purpose of acquiring benefit not only for the particular year but also for the subsequent period of 5 to 10 years. Capital budgeting is the most important and complicated problem of managerial decisions.

Capital budgeting is also known as investment decision making.

(ix) Cash Budget. Cash budget is prepared by the chief accountant of the organisation. It may be prepared either monthly or weekly. Cash budget is a statement to show the estimated amount of cash receipts and payment and balance during the budget period. Simply, it represents the estimated cash receipts and payments over the specific future period.

(x) Master Budget. Master budget is a budget which has to incorporate all functional budgets. The definition of this budget given by the Chartered Institute of Management Accountant, England is as follows. “The summary budget, incorporating its component functional budgets and which is finally approved, adopted, and employed.” It is otherwise called as finalised profit plan. Normally, it has to be approved by the board of directors before it is put into operational activities.

C. Classification According to Flexibility

(i) Fixed Budget. A fixed budget is drawn for a fixed level of activity and a prescribed set of conditions. It has been defined as “a budget which is designed to remain unchanged irrespective of the volume of output or level of activity actually attained”. In the real sense, it does not consider any change in expenditure arising out of changes in the level of activity.

(ii) Flexible Budget. Flexible budget is otherwise called as variable budget. The Chartered Institute of Management Accountants, England, defines a flexible budget “as a budget which by recognizing the difference in behavior between fixed and variable costs in relation to fluctuations in output, turnover or other variable factors such as number of employees is designed to change appropriately with such fluctuations”.

Normally, the flexible budget is prepared in any of the following cases :

  1. Where there are general changes in sales.
  2. Where the business is a new one and it is difficult to forecast the demand.
  3. In an industry which has to be influenced by changes in fashion.

ZERO BASE BUDGETING

The zero bases budgeting, as a managerial tool, have become increasingly popular since the early 1970′s. The main aim of the zero base budgeting is the cost reduction and optimum utilization of resources. It first came into being when former president Jimmy Carter of the United States of America, then Governor of the state of Georgia, introduced it as a means

Definition of Zero base Budgeting

Zero base budgeting is defined as “a planning and budgeting process which requires each manager to justify his entire budget request in detail from scratch (hence zero base) and shifts the burden of proof to each manager to justify why he should spend money at all.

The approach requires that all activities be analyzed in decision packages which are evaluated by systematic analysis and ranked in the order of importance”.

Steps in Zero Base Budgeting

  1. Determination of objectives
  2. Determination of extent of application
  3. Identification of decision making units
  4. Through the cost-benefit analysis
  5. Preparation of budgets 

PERFORMANCE BUDGETING

Any type of budgeting, in order to be successful, must provide performance appraisal as well as follow-up measures. Without performance appraisal and follow-up measures, the budget will not be successful. In this regard, responsibility center and a programme of expected performance in physical units of that centre must be established. According to the National Institute of Bank Management, Mumbai, performance budgeting technique is the process of analyzing, identifying, simplifying and crystallizing specific performance objectives of a job to be achieved over a period in the framework of the organizational objectives. The technique is characterized by its specific direction towards the business objectives of the organization.