There are several budgeting systems used by businesses, and what will work for a small service company probably will not work for a large multinational corporation, like General Electric.
In order to provide the best budget for its needs, a company must identify the standard of its industry. A small service company that prepares tax returns might divide its budget into two seasons: tax season and non-tax season. This would enable it to look at its tax operations, make adjustments for operations that maximized production, and then analyze the slower season to identify ways to cut costs across the annual budget. General Electric, on the other hand, might divide its budgets into months or quarters so that it can analyze the operations in a timely manner, because changes to such a large corporation might require significant lead time and preparation.
This course will look at four budgeting systems:
Continuous budgeting is a process that covers one fiscal year at a time, but in a constant revising motion. In other words, once a period (usually a month) is completed, that budget data is removed, and new budget data for that same period of time is added to cover a new extended year. This budgeting system is also referred to as a rolling budget, because the budget is constantly being rolled over. This type of budget allows management to review the results of the period and make immediate changes for the same period for the next year. Figure 13.1 below should help you understand.
While it enables the company to make changes as the data are fresh, the rolling budget does not provide for changes to the months that have not yet been completed. The budgets for the remaining eleven months will remain as originally created.
Investopedia (2012) defines zero-based budgeting as
a method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a "zero base" and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one.
This is a method that requires every department to build a new budget every year as if it were a new operation, with no biases or predispositions toward favorite vendors or expenditures. The operation is looked at with fresh ideas that can cut costs significantly, as every item on the budget must be detailed as to its requirement for inclusion. Zero-based budgeting is also incredibly time-consuming and costly for a large company, as it has to look at the line items of each department every year without referring to prior data. Often, this type of budgeting process is reserved for a corporate review or strategic plan on a five- to ten-year cycle.
Steven Bragg, a CPA who maintains the Accounting Tools website, defines a static budget as a budget that is
fixed for the entire period covered by the budget, with no changes based on actual activity. Thus, even if actual sales volume changes significantly from the expectations documented in the static budget, the amounts listed in the budget are not changed. (2016, para. 1)
This is the most common budgetary system because it is relatively simple to implement. The company looks at the prior budget, and that becomes the foundation for the new budget, which is based upon a comparison of budgeted amounts with actual results.
A disadvantage of this method is that it does not provide any flexibility based upon changes in production.
A flexible budget is created using the prior-year budget with revisions in the same way as the static budget, but it takes into account the changes that would occur if production changed during the year. This process enables management to make profitability predictions if production increases or decreases.
The flexible budget system is based upon activity, rather than time. The budget uses variable costs per unit so that it can demonstrate how the profits will change if productivity changes. Management can be evaluated based upon more realistic budgets.