Budgeting is a crucial process in accounting and financial management. By creating budgets, businesses can plan for the future, estimate costs and revenue, manage cash flow, and measure performance. There are several types of budgets that serve different purposes. Here are the 7 main types of budgets used in accounting:
1. Sales Budget
The sales budget forecasts upcoming sales revenue based on historical sales data, market conditions, and growth targets It breaks down expected sales by product line, sales territory, distribution channel, or other category. The sales budget is key for production, expense, and other budgets
2. Production Budget
The production budget uses sales estimates to plan manufacturing output levels and costs. It calculates how much inventory is needed to meet forecasted sales demand The budget outlines the required raw materials, labor hours, and factory overhead
3. Direct Materials Budget
This budget determines the quantity and cost of raw materials needed for production. It accounts for desired ending inventory along with estimated material waste. The materials budget helps ensure ample supplies are purchased and on hand.
4. Direct Labor Budget
The direct labor budget plans labor requirements and costs involved in production. It calculates total direct labor hours needed based on the production budget. Labor rates determine the dollar amount of labor costs.
5. Manufacturing Overhead Budget
This budget allocates factory overhead costs like machinery maintenance, equipment depreciation, utilities, and supervisor salaries. Overhead is assigned to units produced based on an estimated overhead rate.
6. Cost of Goods Sold Budget
The COGS budget calculates the total cost to manufacture products that are sold during the budget period. It combines direct material labor and allocated overhead costs assigned to inventory units that are sold.
7. Selling, General & Administrative (SG&A) Expense Budget
This budget forecasts expenses related to sales, marketing and running the business. Examples include salaries, commissions, advertising, rent, utilities, supplies, etc. It helps estimate operating profit.
Careful budgeting across all business functions is crucial for financial control and optimal performance. Companies revise budgets regularly based on updated sales projections and market conditions. Accurate budgets enable data-driven decisions.
The Four Main Types of Budgets and Budgeting Methods
There are four common types of budgets that companies use: (1) incremental, (2) activity-based, (3) value proposition, and (4) zero-based. These four budgeting methods each have their own advantages and disadvantages, which will be discussed in more detail in this guide.
Incremental budgeting takes last year’s actual figures and adds or subtracts a percentage to obtain the current year’s budget. It is the most common type of budget because it is simple and easy to understand. Incremental budgeting is appropriate to use if the primary cost drivers do not change from year to year. However, there are some problems with using the method:
- It is likely to perpetuate inefficiencies. For example, if a manager knows that there is an opportunity to grow his budget by 10% every year, he will simply take that opportunity to attain a bigger budget, while not putting effort into seeking ways to cut costs or economize.
- It is likely to result in budgetary slack. For example, a manager might overstate the size of the budget that the team actually needs so it appears that the team is always under budget.
- It is also likely to ignore external drivers of activity and performance. For example, there is very high inflation in certain input costs. Incremental budgeting ignores any external factors and simply assumes the cost will grow by, for example, 10% this year.
Activity-based budgeting is a top-down type of budget that determines the amount of inputs required to support the targets or outputs set by the company. For example, a company sets an output target of $100 million in revenues. The company will need to first determine the activities that need to be undertaken to meet the sales target, and then find out the costs of carrying out these activities.
In value proposition budgeting, the budgeter considers the following questions:
- Why is this amount included in the budget?
- Does the item create value for customers, staff, or other stakeholders?
- Does the value of the item outweigh its cost? If not, then is there another reason why the cost is justified?
Value proposition budgeting is really a mindset about making sure that everything that is included in the budget delivers value for the business. Value proposition budgeting aims to avoid unnecessary expenditures – although it is not as precisely aimed at that goal as our final budgeting option, zero-based budgeting.
As one of the most commonly used budgeting methods, zero-based budgeting starts with the assumption that all department budgets are zero and must be rebuilt from scratch. Managers must be able to justify every single expense. No expenditures are automatically “okayed”. Zero-based budgeting is very tight, aiming to avoid any and all expenditures that are not considered absolutely essential to the company’s successful (profitable) operation. This kind of bottom-up budgeting can be a highly effective way to “shake things up”.
The zero-based approach is good to use when there is an urgent need for cost containment, for example, in a situation where a company is going through a financial restructuring or a major economic or market downturn that requires it to reduce the budget dramatically.
Zero-based budgeting is best suited for addressing discretionary costs rather than essential operating costs. However, it can be an extremely time-consuming approach, so many companies only use this approach occasionally.
Levels of Involvement in the Budgeting Process
We want buy-in and acceptance from the entire organization in the budgeting process, but we also want a well-defined budget and one that is not manipulated by people. There is always a trade-off between goal congruence and involvement. The three themes outlined below need to be taken into consideration with all types of budgets.
Imposed budgeting is a top-down process where executives adhere to a goal that they set for the company. Managers follow the goals and impose budget targets for activities and costs. It can be effective if a company is in a turnaround situation where they need to meet some difficult goals, but there might be very little goal congruence.
Negotiated budgeting is a combination of both top-down and bottom-up budgeting methods. Executives may outline some of the targets they would like to hit, but at the same time, there is shared responsibility for budget preparation between managers and employees. This increased involvement in the budgeting process by lower-level employees may make it easier to adhere to budget targets, as the employees feel like they have a more personal interest in the success of the budget plan.
Participative budgeting is a roll-up approach where employees work from the bottom up to recommend targets to the executives. The executives may provide some input, but they more or less take the recommendations as given by department managers and other employees (within reason, of course). Operations are treated as autonomous subsidiaries and are given a lot of freedom to set up the budget.
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Types of Budgets and Budget Concept
What are the different types of budgeting?
Incremental, Activity-Based, Value Proposition, and Zero-Based Budgeting offer distinct approaches to financial planning, catering to different organizational needs and fostering innovation. Budgeting is necessary for management and planning. This article dives further into the popular budget types and budget categories.
What are the different types of accounting budgets?
There are dozens of types of budgets for accounting to consider, with many of them available online as downloadable templates. Businesses often employ budgeting software for a more hands-off approach to tracking expenses, but it’s still good to know what kinds of budgets are available. Here are some types of accounting budgets: 1. Basic budget
What is budgeting in business?
In business, budgeting is estimating a company’s expected earnings (the money the firm receives from selling goods and services) and expenditures (the money it spends on paying expenses and bills) over a certain period in the future.
What are the different types of budgeting tools?
Some budgeting tools allow you to create a budget in a spreadsheet, while others allow you to input your financial data. There is also software with analytical reports, profitability forecasts, and collaboration features. What Are the 4 Stages of the Budget Process? There are 4 key stages in the budget process.
