Question

• Explain 2 different types of budgets, and discuss why a company would choose one type of budget over another.
• Discuss the advantages and disadvantages of the zero-based budgeting approach.

Answer 1

A budget is an estimation made for the future regarding cost, revenue, number of units to be sold, planned expenditure to be made on certain project etc.

There are several types of budgets. Two of them are explained below:

1. Cash budget

A cash budget estimates the amount of cash that will be received or that will be paid during  a specified period of time usually a year.

It helps a business in managing its cash so that it has sufficient funds to meet its needs.

2. Production budget

A production budget estimates the number of units to be produced during a specified period of time. It helps a manufacturing business in managing its production and sales. A business has to ensure that it has sufficient units to meet the demand in the market. Further, it has to be sure that large number of units are not lying in the warehouse as it will add to the carrying costs of the business.

A business may choose one type of budget over another depending its business needs. Like a manufacturing business will prefer production budget over other budgets.

Zero based budgeting

a zero based budget is prepared as if it is prepared for the first time. Some of the advantages are:

• These lead to lower cost as these are prepared afresh and are not affected by previous years’ price increases or decreases.

some of the disadvantages are:

• Zero based budgets are expensive to prepare as these are prepared from zero level. All the computations and estimations are made afresh.
• these may be biased towars meeting short-term goals.
• Zero based budgeting is time consuming.