Budgets can be used effectively to control activities and hence costs within an organisation.
Budgets are only effective if managers agree with them and are motivated enough to act according to the framework set out by that budget.
Types of budget:
Fixed budget – A master budget is based on planned volumes of production and sales. It does not include the provision for variability in demand over time that may differ from the budget.
Flexible budget – This recognises different cost behaviours over time and is designed to change as volume of activity changes. Future costs are based on past marginal costings (High/Low method).
Incremental budget – Effective if all factors are the same in the next trading period (efficiency, marketplace and sales forecast). This makes budgetting a simple process of increasing on last years budget by the forecast for growth or inflation. It can conceal inefficiencies, through slack and wasteful spending creeping into the budget.
Activity based budgeting – Based on a framework of cost drivers and their real rate.