Preparing Flexible and Zero-Based Budgets
Budgets are essential for effective financial planning and control. Two notable types are flexible budgets and zero-based budgets.
Flexible Budgets adjust to changes in activity levels. They provide a more accurate reflection of costs and revenues at various levels of production or sales. This type of budget is useful for performance evaluation, as it allows for comparison against actual results, taking into account the actual level of activity.
Zero-Based Budgets (ZBB) require all expenses to be justified for each new period, starting from a 'zero base.' Unlike traditional budgeting, which often uses previous budgets as a baseline, ZBB allocates resources based on current needs and priorities. This method encourages cost management and eliminates unnecessary expenditures.
In Kenya, businesses may adopt these budgeting techniques to enhance efficiency and accountability, especially in a competitive market. The Companies Act 2015 emphasizes the importance of sound financial practices, making budgeting a critical component of corporate governance.
Both budgeting techniques require thorough analysis and understanding of the business environment to be effective.
Key points to remember
- Flexible budgets adjust for changes in activity levels.
- Zero-based budgets require justification of all expenses.
- Both budgets enhance financial planning and control.
- Use flexible budgets for performance evaluation.
- ZBB encourages cost management and prioritization.
Worked example
Flexible Budget Example
Assumptions:
- Fixed Costs: KES 200,000
- Variable Cost per Unit: KES 50
- Sales Price per Unit: KES 100
- Actual Units Sold: 1,500
Flexible Budget Calculation:
- Sales Revenue:
1,500 units × KES 100 = KES 150,000 - Total Variable Costs:
1,500 units × KES 50 = KES 75,000 - Total Costs:
Fixed Costs + Total Variable Costs = KES 200,000 + KES 75,000 = KES 275,000 - Net Income:
Sales Revenue - Total Costs = KES 150,000 - KES 275,000 = KES -125,000
Zero-Based Budget Example
Assumptions:
- Department A requires KES 300,000 for operations.
- Department B requires KES 150,000 for new projects.
Zero-Based Budget Calculation:
- Department A Justification:
- Justify KES 300,000 based on current operational needs.
- Department B Justification:
- Justify KES 150,000 based on expected project outcomes.
Total Budget:
KES 300,000 + KES 150,000 = KES 450,000
Both budgets ensure resources are allocated effectively based on current needs.