How can a strategic budget be prepared

Other approaches in addition to the top-down and bottom-up approaches are a combination approach and the zero-based budgeting approach.

In the combination approach, guidelines and targets are set at the top while the managers work to develop a budget within the targeted parameters. Zero-based budgeting begins with zero dollars and then adds to the budget only revenues and expenses that can be supported or justified. Figure illustrates the difference between traditional budget preparation and zero-based budgeting in a bottom-up budgeting scenario.

The advantage to zero-based budgeting is that unnecessary expenses are eliminated because managers cannot justify them. The drawback is that every expense needs to be justified, including obvious ones, so it takes a lot of time to complete.

A compromise tactic is to use a zero-based budgeting approach for certain expenses, like travel, that can be easily justified and linked to the company goals. Often budgets are developed so they can adjust for changes in the volume or activity and help management make decisions.

A flexible budget adjusts the cost of goods produced for varying levels of production and is more useful than a static budget, which remains at one amount regardless of the production level. A flexible budget is created at the end of the accounting period, whereas the static budget is created before the fiscal year begins.

In the flexible budget, the budgeted costs are calculated with actual sales, whereas in the static budget, budgeted costs are calculated with budgeted sales. The flexible budget allows management to see what they would expect the budget to look like based on the actual sales and budgeted costs.

Flexible budgets are addressed in greater detail in Prepare Flexible Budgets. In order to handle changes that occur in the future, companies can also use a rolling budget , which is one that is continuously updated. Rolling budgets allow management to respond to changes in estimates or actual occurrences, but it also takes management away from other duties as it requires continual updating.

Figure shows an example of how a rolling quarterly budget would work. Notice that as one month rolls off is completed another month is added to the budget so that four quarters of a year are always presented. Each individual who exercises control over spending should have a budget specifying limits on that spending. Most organizations will create a master budget—whether that organization is large or small, public or private, or a merchandising, manufacturing, or service company.

A master budget is one that includes two areas, operational and financial, each of which has its own sub-budgets. The operating budget spans several areas that help plan and manage day-to-day business. The financial budget depicts the expectations for cash inflows and outflows, including cash payments for planned operations, the purchase or sale of assets, the payment or financing of loans, and changes in equity.

Each of the sub-budgets is made up of separate but interrelated budgets, and the number and type of separate budgets will differ depending on the type and size of the organization. For example, the sales budget predicts the sales expected for each quarter. The direct materials budget uses information from the sales budget to compute the number of units necessary for production.

This information is used in other budgets, such as the direct materials budget, which plans when materials will be purchased, how much will be purchased, and how much that material should cost. You will review some specific examples of budgeting for direct materials in Prepare Operating Budgets. Figure shows how operating budgets and financial budgets are related within a master budget. The Role of Operating Budgets An operating budget consists of the sales budget, production budget, direct material budget, direct labor budget, and overhead budget.

These budgets serve to assist in planning and monitoring the day-to-day activities of the organization by informing management of how many units need to be produced, how much material needs to be ordered, how many labor hours need to be scheduled, and the amount of overhead expected to be incurred.

The individual pieces of the operating budget collectively lead to the creation of the budgeted income statement. Management understands that it needs to have on hand the 1, trainers that it estimates will be sold. It also understands that additional inventory needs to be on hand in the event there are additional sales and to prepare for sales in the second quarter. This information is used to develop a production budget. Each trainer requires 3. Knowing how many units are to be produced and how much inventory needs to be on hand is used to develop a direct materials budget.

The direct materials budget lets managers know when and how much raw materials need to be ordered. The same is true for direct labor, as management knows how many units will be manufactured and how many hours of direct labor are needed.

The necessary hours of direct labor and the estimated labor rate are used to develop the direct labor budget. A company with a long term vision and goals have to be very constructive and accurate in designing such a budget. This article has been a guide to Strategic Budgeting and its definition. Here we discuss the process, examples of strategic budgeting along with its importance and detail explanation.

You may learn more about financing from the following articles —. Free Accounting Course. Login details for this Free course will be emailed to you. Forgot Password? Article by Vivek Shah. What is Strategic Budgeting? Explanation A long-term strategic plan usually spreads out the 5-year plan to set goals. Alternatively, you might plan to eliminate some products. The Electro-Revolving model, for example, is faring poorly.

Ask your coworkers for their ideas about costs as well. Is your budget defensible? Could you do with one extra staff member instead of two? If not, be sure you can make a good argument as to why not.

You have 1 free article s left this month. That review is critical, as different parts of the organization will have similar questions related to crisis response and recovery. Everyone will need to be on the same page. Teams in sales and marketing, for instance, must have a common understanding of when the economic return and the next normal officially start—and therefore how to budget for travel and expenses. Finance teams will need to determine which of the economic scenarios they projected actually materialized and then systematically examine how various strategic initiatives launched during the crisis have affected corporate performance in revenue, pricing, sales volume, and competition.

Consider the case of a vertically integrated retailer. When its brick-and-mortar stores needed to close in April as a result of COVID, the retailer quickly invested in an e-commerce platform and a logistics partnership to facilitate sales.

Those in more stable industries are looking at launching new products and investing in new technologies and business partnerships in the next normal. For example, a pharmaceutical company is investigating digital sales models to complement its traditional go-to-market approaches.

Traditionally, business leaders have balked at using zero-based budgeting as a means to understand the critical drivers of a business. The approach—in which expenses must be justified for each budget period—is too arduous, they have argued, involves too much micromanagement, and poses countless other challenges. Many of those objections evaporated, however, in the wake of the COVID crisis—probably because business leaders no longer faced the base decision about whether to shift spending but rather the more urgent choice of how much and where.

For example, a mining company now force-ranks large capital-expenditure projects along a spectrum of potential returns and risks, while a major hospital chain has reallocated conference and travel budgets toward telemedicine and work-from-home capabilities.

Realize it or not, CFOs have been using zero-based-budgeting principles to determine what levels of spending are required to keep the lights on or to support recovery. Whether CFOs realize it or not, they have been using zero-based-budgeting principles and approaches to determine what levels of spending are truly required to keep the lights on or to support recovery efforts.

As CFOs are preparing their budgets, many of them recognize that they are already starting from zero in some areas. Rather than revert to precrisis ways of working, CFOs should use this opportunity to reset the base in other areas of the organization, as well. In collaboration with business-unit leaders, CFOs and finance teams will need to conduct a rigorous review of spending in key areas.

What would that look like? Some companies convene red and blue teams regularly to review proposed spending. In most companies, budgets are typically fixed for the year , but in response to the COVID crisis, many businesses have had to be more flexible, confidently shifting resources as needed to survive.

To monitor the situation in real time, for instance, they have deployed spending control towers , cash war rooms, and dashboards. And they are using different kinds of key performance indicators KPIs , such as the cash-burn rates of suppliers and distributors and the growth rate of COVID cases.