Methods of Budget Setting Nursery Management Understanding and Managing Finance. .

Methods of budget-setting In the previous section, we looked at the process by which a budget comes into being. Here we look at the different budgeting methods and principles. These methods may be used across the whole of a company, or particular parts of it, and the methods used may vary from year to year, depending upon the circumstances.

Budgets – Time horizons Periodic budget This is a one-off budget set for a year (e.g.) It is normally broken down into monthly or weekly amounts Continual Budget This will be updated continually (still for one year, but a new month will be added to replace the one which has passed.)

Methods used in budget-setting Incremental Budgeting: - same as last year with a bit added Zero Base Budgeting - budget holders required to justify why any money is needed Activity Based Budgeting - those responsible for activities which incur costs hold the budgets Standard costing - standard quantities and costs used to generate targets. Sensitivity Analysis - computer software used to answer ‘what-if’ questions.

Activity-Based Budgets Different Forms of Budgeting Incremental Budgets Zero-Base Budgets Activity-Based Budgets Standard Costs Sensitivity Analysis

Incremental Budgeting Traditional form of budgeting, common in local and central government Costs and allocations of monies tend to be on a ‘historical’ basis, i.e. what happened in previous years Adjustment (increments) are made on the basis of changes (e.g. inflation, increases in productivity, workforce etc.) that happen from year to year. Often used for ‘discretionary’ budgets (i.e. where budget holder is responsible for allocating a sum of money within a department) No clear relationship between the input or output (e.g the raw materials required or the level of sales produced)

Zero-Base Budgeting (ZBB) Draws on the philosophy that ALL spending needs to be justified. All budgets are allocated a zero base, and will be increased from this only if a good case can be made out for the money Senior management will be using the criterion of ‘value for money’ to allocate scarce resources. ZBB encourages managers to adopt a questioning approach; this leads to more strategic thinking and allocation of resources to enable this strategy to happen Clear links required between input/output and the resourcing

Activity-Based Budgeting (ABB) Derives from the philosophy of Activity-Based Costing, that it is activities which drive costs. This is applied to the the Budget process. If ‘cost-driving’ activities can be identified, then the cost of the output can be achieved more accurately) Central feature: budget holders (those who are responsible for meeting a particular budget) have control over the events that affect performance in their area. ABB tries to generate budgets in such a way that the manager who has control over these cost drivers is accountable for the costs. Typical problems: increased levels of activity generated from outside the manager’s control, e.g. Manufacturing Budget thrown into disarray by a new sales contract

Standard Costing Embodies the idea that standard quantities and costs can be planned for individual units such as sales items, labour rates, raw materials etc. The standards are targets, and become benchmarks by which actual performance s measured. The targets may be derived from experience, market assessments, current rates (e.g. labour, fees etc.), but should be realistic. Variances (differences between the budgeted amounts and the actual amounts) are always based on standards.

Sensitivity Analysis This is a tool used in setting technically complex budgets: It investigates changes to profit due to adjustments in key variables It identifies key areas for managers to focus on for maximum effect In order to use it, managers need to: Identify key questions to be answered – e.g. what is the effect on profits of 10% decrease in sales? Or a 10% increase in cost of sales? Use of spreadsheets or other types of computer software in order to create ‘what-if’ analyses, perform goal-seeking or other complex tasks.

Activity 2. How might any disadvantages be overcome? 1. What do you think might be the advantages and disadvantages of zero-based budgeting? 2. How might any disadvantages be overcome?

Solution Little Wastage of Resources Advantages Little Wastage of Resources Strategic use of resources, enable plans to be fulfilled more easily Disadvantages Time Consuming Managers can often feel threatened by ZBB The disadvantages might be countered by using the approach selectively, for example only every third year, or on particular budgets which tend to require strategic input, e.g. training, advertising, research and development.