Type and Purpose of Budgets

Type and Purpose of Budgets

Types and Purposes of Budgets

Master Budget

  • A master budget is a comprehensive budgeting plan that includes all other budgets and financial forecasts.
  • Aids in coordinating various business activities and aligns them to realise business objectives.
  • Good for gaining a holistic understanding of a business’s plan for the upcoming accounting period.

Operating Budget

  • An operating budget outlines expected revenues and expenses within a specific period.
  • Useful for predicting cash flow, guiding day-to-day operational decisions, and setting financial goals.
  • It covers various components including sales, production costs, and overheads.

Cash Budget

  • A cash budget is a budget focusing on a company’s cash inflow and outflow.
  • It’s vital for ensuring the company has sufficient cash to finance its operations and manage short-term financial obligations.
  • Enables businesses to plan for future financing needs and manage liquidity risks.

Capital Expenditure Budget

  • A capital expenditure budget outlines the planned investments in long-term assets such as machinery and property.
  • It helps in capital rationing as it ranks various investment proposals based on profitability and risk.
  • It provides a roadmap for significant financial commitments and their ultimate impact on future profitability.

Static and Flexible Budget

  • A static budget remains unchanged regardless of changes in output or sales volume.
  • A flexible budget, conversely, adjusts based on changes in business activities or output.
  • Both budget types have their places: static budgets can be useful for control, while flexible budgets adapt to changing business conditions and are better for performance evaluation.

Zero-Based Budgeting

  • Zero-based budgeting (ZBB) involves justifying every expense for each new period, starting from scratch.
  • Promotes cost efficiency, critical thinking, and resource allocation based on needs and benefits.
  • It can be time-consuming but is effective for controlling costs and curbing wasteful spending.

Activity-Based Budgeting

  • Activity-based budgeting (ABB) focuses on budgeting around business activities.
  • It enables more accurate cost attribution by considering the resources consumed by each activity.
  • This method can enhance cost transparency, promote efficiency, and support strategic decision-making.