management contribute to the process;
it encourages a broad, organisation-wide perspective consistent with government priorities as
•
senior management set the strategic targets and constraints which then cascade down through the organisation;
it leads to a greater understanding of how the actions and demands of individual areas impact
•
the organisation as a whole; and
the detailed budget is constructed by those that are responsible for delivering the services.
•
However, an ineffective hybrid approach can result in significant amounts of time and effort being spent in negotiation and iteration, with senior management ultimately having to impose budget cuts to satisfy organisational constraints. Approaches to mitigating this risk include:
involving line management in the target setting process;
•
providing opportunity for operational areas to submit proposals for funding priorities early. These
•
proposals are reviewed and vetted prior to resource allocation;
ensuring organisational goals, constraints and planning assumptions are clear and communicated
•
at the beginning of the budget process and throughout the budget cycle;
incorporating longer-term goals and constraints to guide managers in allocating resources; and
•
integrating budget priorities and allocations into the strategic and operational planning cycle.
•
There are circumstances where a largely bottom-up budgeting approach might be appropriate to an organisation. In particular:
when an organisation has undergone substantial change (for example, after machinery of
•
government changes or where there has been a redirection of government priorities) and a bottom-up approach is useful in setting the budget baseline;
when an organisation’s operations change significantly year to year, for example, project-based
•
organisations; or
as a periodic ‘zero-based’ retesting of budget assumptions and resource allocations, for example,
•
on a triennial basis.
A primarily top-down budgeting approach is the most appropriate approach in some circumstances, for example, where a organisation has to identify substantial budget savings in a short space of time or in circumstances where additional budget discipline is needed.
Determining the budget approach 3.2.2.
Most organisations prepare budgets using one or a combination of the following methods:
incremental budgeting (otherwise referred to as traditional budgeting);
•
zero-based budgeting;
•
activity-based budgeting; or
•
performance-based budgeting (including program-based budgeting and output-based
•
budgeting).
Table 4 describes the key characteristics of each method, and their main advantages and disadvantages.
Developing and implementing a comprehensive internal budget
Table 4: Budget development methodologies
Method Characteristics
Incremental or traditional budgeting
Description:
The previous year’s budget or actual results provide a base line for the current year, adjusted for the removal or addition of one-off budget impacts, the addition of new measures, the removal of lapsed programs and otherwise updated for indexed changes, such as inflation adjustments and productivity gains.
Advantages:
close linkage to the way external
•
budgets are adjusted;
relatively simple and easy to
•
understand; and
provides managers with a stable
•
and consistent approach to budgeting.
Disadvantages:
assumes activities are largely
•
unchanged from last year;
promotes spending to meet
•
the budget rather than focusing on identifying savings and efficiencies; and
not readily adaptable to changed
•
organisational priorities.
Zero-based budgeting
Description:
Requires preparation of the next year’s budget as if it was a new, rather than continuing, budget. That is, every aspect of the budget must be justified.
This method endeavours to redirect efforts and funds from lower priority current programs to higher priority new programs, improve efficiency and effectiveness and therefore reduce spending.
Advantages:
greater alignment of resource
•
allocation to output and program delivery;
more adaptive to changing
•
priorities and circumstances;
active involvement of operational
•
managers; and
focuses on value for money as
•
each budgeted amount must be justified.
Disadvantages:
increased complexity, requiring
•
greater time and cost to deliver budget; and
increased workload may
•
not be justifiable where an organisation’s activities experience little fluctuation.
Method Characteristics Activity-based
budgeting
Description:
Concentrates on factors that drive costs and justifies expenditure on the basis of activities performed in relation to pre-determined drivers. Places responsibility on the manager with responsibility for the driver.
Advantages:
enables managers to input and
•
measure budgets in operational terms;
provides opportunities to examine
•
work practices and eliminate non value-adding activities; and close linkage to operational
•
planning.
Disadvantages:
greater complexity as it requires
•
managers to understand what activities drive their budget and estimate activity volume.
Performance -based budgeting
Description:
The various performance-based budgeting approaches begin with an assessment of what the organisation is trying to achieve. The activities required to achieve each output are identified and costed (generally using activity-based budgeting).
Advantages:
links resources (inputs) to the
•
organisation’s deliverables (outputs);
strongly integrates the budget and
•
strategic and operational plans;
greater alignment to source of
•
appropriation funding; and close linkage to external
•
performance measures in Portfolio Budget Statements.
Disadvantages:
greater complexity in aligning
•
organisational and output responsibilities and in allocating corporate costs;
budgets are ineffective if
•
performance measures are not clearly articulated up-front;
greater time and effort involved
•
in collecting output and program indicators; and
allocation of internal costs (for
•
example corporate overheads) can be arbitrary unless the organisation has effective allocation approaches.
Conceptually, a budgeting approach with elements of zero-based budgeting and performance-based budgeting would generally be considered better practice as the budget links to the organisation’s goals, priorities and outputs and has been fully justified. However, given the complexity, time
Developing and implementing a comprehensive internal budget Some techniques organisations use to incorporate zero-based and performance-based concepts
into their budgeting practices include:
limiting the use of zero-based budgeting to a select number of discretionary cost items (for
✓
example, suppliers) or to a select number of programs;
applying full zero-based budgeting on a periodic basis (for example, triennially) rather than every
✓
year; and
applying performance-based budgeting using a limited number of cost drivers as ‘intuitive
✓
proxies’—that is, key drivers (such as headcount) which are likely to explain the majority of activity and provide a reasonable approximate of other activity in the absence of more specific drivers.