BUS4012 Introduction to Business Finance
Question 3
Solution:
a) Discuss the advantages and disadvantages of the different approaches to budgeting that could be used by AAA
The formulation of a well-defined financial management
strategy is imperative for AAA's proposed business expansion. The
implementation of a budgeting system is considered to be one of the most
efficacious approaches to attaining this objective. Various methodologies exist
for budgeting, each presenting its own set of benefits and drawbacks. The
purpose of this memorandum is to analyse various budgeting methodologies that
AAA may contemplate and evaluate their respective advantages and disadvantages.
Zero-based budgeting
With zero-based planning, you start from scratch every year and make a new budget. This method gets managers to explain every expense, which can help them better control costs. But it can take a lot of time and needs a lot of work from everyone in the organisation.
Activity-based budgeting
Activity-based planning means figuring out and analysing the things that make an organisation spend money. This method gives managers more knowledge about prices and helps them use their resources more wisely. But it can be hard to put into place and takes a lot of resources to gather data.
Incremental budgeting
Incremental budgeting is a budgeting method that involves making small adjustments to the previous period's budget to create a new budget for the upcoming period. This approach assumes that the previous budget is a good starting point and only minor changes are needed to account for any changes in the upcoming period. Incremental budgeting is commonly used in organisations where the budgeting process is routine and predictable.
The aforementioned methodology entails modifying the budget of the
preceding year to accommodate any alterations in the business milieu. One of
the benefits of incremental budgeting is its ease and speed of preparation.
Nonetheless, this approach fails to incentivize cost management or inventive practises and presupposes the continued applicability of prior budgetary allocations.
Zero-based budgeting
Zero-based budgeting is a financial planning approach that requires each budget cycle to start from a "zero base," meaning that all expenses must be justified for each new period, regardless of whether they were included in the previous budget cycle. This approach is in contrast to traditional budgeting methods, which typically involve incremental adjustments to the previous budget. The practise of zero-based budgeting entails the development of a fresh budget annually, without any consideration of the previous year's budget.
The implementation of
this methodology incentivizes managers to provide rationale for every
expenditure, thereby promoting enhanced cost management. Nevertheless, the
process can be laborious and demands substantial exertion from every echelon of
the establishment.
Activity-based budgeting
Activity-based budgeting is a
budgeting approach that focuses on the specific activities that drive costs
within an organisation. This method involves identifying and analysing the
various activities that contribute to the production of goods or services, and
then allocating resources based on the expected costs of those activities. By
using activity-based budgeting, organisations can gain a more accurate
understanding of their cost structure and make more informed decisions about
resource allocation. The process of activity-based budgeting entails the
identification and analysis of the activities that are responsible for driving
costs within an organisation. This methodology offers a more comprehensive
analysis of expenses, thereby enabling managers to optimise resource
allocation. Nevertheless, the implementation of this approach may prove
intricate and necessitate substantial resources for data collection.
Rolling budgeting
Rolling budgeting is a budgeting
technique that entails the development of a budget for a predetermined
timeframe, such as a quarter, and subsequently revising it as the period
advances. The utilisation of this approach enables greater flexibility and
adaptability in addressing alterations in the commercial milieu. Nevertheless,
the implementation of this approach may pose difficulties and necessitate a
substantial financial commitment to acquire budgeting software.
Overall, there exist multiple budgeting strategies that AAA
can contemplate, each with its respective advantages and disadvantages.
Selecting a budgeting methodology that is consistent with AAA's strategic goals
and facilitates the company's expansion plans is imperative. It is recommended
that a comprehensive evaluation of various budgeting methodologies be conducted
in order to determine the most appropriate approach that aligns with the
specific requirements of AAA.