Tuesday, 20 March 2012

Budgeting Process & Types

Definition :
A budget can be defined as a quantitative economic plan in respect of a period of time.

Functions of a budget:

Budgets can fulfil one or more of the following functions:
Different budgeting methodologies allow the budget to perform these roles in different ways and to differing extents. For example, the planning programming approach (see section 4.3) can be clearly seen as underpinning the decision-making function. Conversely, one of the criticisms of the incremental approach is that it does not allow for full consideration of proposed changes in action as it is a more backward-looking method; it could be argued that incremental budgeting does not support decision making very well.
1.Incremental Budgeting :

Public sector budgets in Northern Ireland and elsewhere in the UK typically rely on the incremental approach (although the Comprehensive Spending Review 2007 process did involve a series of departmental baseline reviews). The previous year’s budget for a department or division is carried forward for the next annual budget. It is adjusted for known factors such as new legislative requirements, additional resources, service developments, anticipated price and wage inflation and so on.

>>It is known as incremental budgeting because the process is mainly concerned with the incremental (or marginal) adjustments to the current budgeted allowance. In that respect it is rather similar to the NI block funding: any changes are up or down from the existing funding for particular activities.
>>According to the Chartered Institute for Public Finance and Accounting (CIPFA), a key characteristic of the approach is that budget preparation is a process of negotiation and compromise. "Incremental budgeting is therefore based on a fundamentally different view of decision making than more rational approaches."
>>This is because negotiated settlements between interested parties require a willingness to compromise. If consensus breaks down, compromise cannot be reached and the incremental process becomes invalid. According to CIPFA, use of this model, therefore, requires a relatively stable form of representative government.
Advantages of incremental budgeting
·  easily understood (as it is retrospective), makes marginal changes and secures agreement through negotiation;
·  administratively straightforward (and therefore cheap);
·  allows policy makers to concentrate of the key areas of change. Ministers, elected representatives and senior officials are not required to study long and detailed budgetary documents;
·  particularly useful where outputs are difficult to define/quantify; and,
·  stable and, therefore, changes are gradual.

Disadvantages of incremental budgeting
·  backward looking – focus more on previous budget than future operational requirements and objectives;
·  does not allow for overall performance overview;
·  does not help managers identify budgetary ‘slack’;
·  often underpinned by data or service provision which is no longer relevant or is inconsistent with new priorities;
·  encourages systemic inertia and ‘empire building’;
·  tends to be reactive rather than proactive; and,
·  assumes existing budget lines are relevant and satisfactory.

2. Zero-Based Budgeting :

Zero-based budgeting – unlike the incremental approach – starts from the basis that no budget lines should be carried forward from one period to the next simply because they occurred previously. Instead,
  before the budget is allocated. It is, therefore, less ‘how should we deliver this service with the money available’ and more ‘here’s what we have to achieve, different options for achieving it and the budget required for each of those options’.

The approach relies upon the involvement of all executive managers. It requires the organisation’s objectives to be clearly stated – as with any budget process – but also considers and assesses different ways of delivering those objectives

The process requires specification of minimum levels of service provision, the current level, and an ‘incremental’ level – either between the minimum and the current or an improvement over the current level. Options for delivering at each level can then be evaluated and a justification put forward along with the request for resources.

Advantages of zero-based budgeting
·  allows questioning of the inherited position and challenge to the status quo;
·  focuses the budget closely on objectives and outcomes;
·  actively involves operational managers rather than handing them down a budget from above;
·  can be adaptive to changes in circumstances and priorities; and,
·  can lead to better resource allocation.

Disadvantages of zero-based budgeting
·  more time consuming than incremental budgeting (i.e. it may become overly bureaucratic and produce excessive paperwork);
·  need for specialised skills/training;
·  difficulties can arise in the identification of suitable performance measures and decision/prioritisation criteria (if there is insufficient information in some areas ranking them could also be problematic);
·  the specification of a minimum level of service provision (if below the current level) may demotivate managers;
·  questioning of the inherited position can be seen as threatening to organisations and their people (so careful management of the people element is essential); and,
·  may be difficult to cost and estimate resource requirements for options different from the current practice (giving rise to greater uncertainty).

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