According to Plunkett and Attner, budgeting requires (1) setting goals, (2) planning and scheduling to reach the goals, (3) identifying and pricing resources, (4) locating needed funds, and (5) adjusting goals, plans; and resources to match actual fund availability.
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Any one of the following standardized approaches can be used in the preparation of budgets.
1. Top down Budgeting:
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These budgets are prepared by senior managers and are passed down to lower levels end the lower level managers are expected to operate within these budgets. There may or may not be any input from the lower level managers.
In preparing these budgets, top management must take into consideration all relevant factors and carefully analyze these factors so that they do not miss or neglect any significant information about opportunities and risks. It is advisable to ask for input from others during budget building.
2. Bottom-up Budgeting:
Also known as “grassroots” budgeting, the bottom-up budgeting is based upon the knowledge and experiences of all organization members. Employees who are directly involved in various operations contribute input in building the budget that affects them.
These people are experienced and knowledgeable about these operations. Furthermore, since many departments are interdependent, the members would prepare inputs with respect to the respective needs and priorities of such departments in a cooperative spirit. As these inputs move up the hierarchy, various views are consolidated to create a comprehensive framework. It is a kind of participative style of budget building and since the employees are primarily responsible for preparing these budgets, they would make all efforts to ensure that these budgets are properly implemented.
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This approach of budget preparation gains additional significance because most companies are now downsizing and decentralizing authority so that the decentralized divisions become more autonomous and they set their own priorities, run their own operations and construct their own budgets.
3. Zero-Based Budgeting (ZBB):
Most of the budgets are prepared on the basis of the budgets of previous time periods. The budgets tend to lean on continuity so that the individuals preparing the budget make decisions on the basis of previous year’s budget and they must justify any added expenditures that are to be undertaken in the current budget.
Such a process usually builds a bias towards continuing the same activities year after year, assuming that the past expenditures must have been justified. This process is harmful, especially when there have been changes either in the environmental factors or in the organizational objectives.
Zero-based budgeting seeks to remedy this deficiency. The budget is constructed from a zero base, as if it was the very first budget of the organization. The preparation of the budget builds up the costs from zero rather than starting with current level of costs. With each budget so built, there should be justification for every dollar, starting from scratch.
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The organizational plan is broken down into departmental, functional and local plans and these various plans are prioritized on the basis of evaluation of purpose, costs, benefits and any other factors. The ZBB process involves three steps. These are:
1) Activities are divided into parts known as “decision packages”. Each decision package contains all the information about an activity including the purpose, cost, benefit and possible outcome if the activity is approved or disapproved.
2) All such activities are evaluated and ranked on the basis of benefit to the organization. The activities, with the highest ranks will get immediate and first attention and the activities at the lowest ranks would get the lowest priority including elimination of such activities whose benefits can no longer be justified relative to the associated costs.
3.) Once the priorities have been assigned to activities then the organization’s resources are budgeted according to these priorities. Zero-base budgeting has many advantages over the conventional budgeting techniques.
First, it provides more rational justification as to whether an activity should be continued or whether it should be terminated. Second, since ZBB originates at the lower level of management and moves upwards, it allows for greater participation of all concerned people in the planning process.
Third, since managers must quantify each alternative, the measures needed for comparison are objective in nature and hence the assessment and evaluation of each activity is clear and unambiguous. Finally the low priority activities can be eliminated without considerable economic losses and more energies can be spent an high priority activities that can result in additional benefits.
The importance of zero-base budgeting was significantly highlighted when the President of the United States implemented it in various agencies of the government. As he himself explains.
“From my experience in government as well as the experiences of corporations in the business world, a number of clear-cut benefits from an effective zero-base budgeting effort can be cited. These benefits include:
i. Focussing the management process on analysis and decision making rather than simply on numbers – in other words, the what, why, and how issues as well as how much.
ii. Combining planning, budgeting and operational decision making into one process.
iii. Forcing managers to evaluate in detail the cost-effectiveness of their operations. This includes specific programs both new and old – all of which are clearly identified rather than functionally buried.
iv. Providing a system to trade off between long term and short term needs during the budgeting period, as well as a follow-up tool on cost and performance during the year.
v. Allowing for quick budget adjustments or resource shifts during the year, if necessary, when revenues fall short. In so doing, zero-base budgeting offers the capability to quickly and rationally modify goals and expectations to correspond to a realistic and affordable plan of operation.
vi. Identifying similar functions among different departments for comparison and evaluation.
vii. And most important to me, broadly expanding management participation and training in the planning, budgeting and decision-making process.”
Zero-base budgeting process does have some drawbacks. First, the process is more costly and requires more time and sometimes unnecessary efforts. Secondly middle management is usually reluctant to submit their program to such extensive scrutiny. Finally, it may sometime be considered as a suppressant on spending rather than an opportunity to create new ideas and programmes.
