Question

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Briefly describe the three types of budgets mentioned in the text and include what purpose each type serves?

Answer 1

BALANCED BUDGET
A government budget is said to be a balanced budget if the estimated government expenditure is equal to expected government receipts in a particular financial year. Advocated by many classical economists, this type of budget is based on the principle of “living within means.” They believed the government’s expenditure should not exceed their revenue.
Though an ideal approach to achieve a balanced economy and maintain fiscal discipline, a balanced budget does not ensure financial stability at times of economic depression or deflation. Theoretically, it’s easy to balance the estimated expenditure and anticipated revenues but when it comes to practical implementation, such balance is hard to achieve.

MERITS OF A BALANCED BUDGET

• Ensures economic stability, if implemented successfully.
• Ensures that the government refrains from imprudent expenditures.

DEMERITS OF A BALANCED BUDGET

• Unviable at times of recession and does not offer any solution to problems such as unemployment.
• Inapplicable in less developed countries as it limits the scope of economic growth.
• Restricts the government from spending on public welfare.

SURPLUS BUDGET
A government budget is said to be a surplus budget if the expected government revenues exceed the estimated government expenditure in a particular financial year. This means that the government’s earnings from taxes levied are greater than the amount the government spends on public welfare. A surplus budget denotes the financial affluence of a country. Such a budget can be implemented at times of inflation to reduce aggregate demand.

DEFICIT BUDGET
A government budget is said to be a deficit budget if the estimated government expenditure exceeds the expected government revenue in a particular financial year. This type of budget is best suited for developing economies, such as India. Especially helpful at times of recession, a deficit budget helps generate additional demand and boost the rate of economic growth. Here, the government incurs the excessive expenditure to improve the employment rate. This results in an increase in demand for goods and services which helps in reviving the economy. The government covers this amount through public borrowings (by issuing government bonds) or by withdrawing from its accumulated reserve surplus.

MERITS OF A DEFICIT BUDGET

• Helps in addressing public concerns such as unemployment at times of economic recession.
• Enables the government to spend on public welfare.

DEMERITS OF A DEFICIT BUDGET

• Can encourage imprudent expenditures by the government.
• Increases burden on the government by accumulating debts.

(A)  Classification According to Time -

1. Long Term Budget:

The budgets are prepared to depict long term planning of the business. The period of long term budgets varies between five to ten years. The long term planning is done by the top level management; it is not generally known to lower levels of management. Long time budgets are prepared for some sectors of the concern such as capital expenditure, research and development, long term finances, etc. These budgets are useful for those industries where gestation period is long i.e., machinery, electricity, engineering, etc.

2. Short-Term Budget:

These budgets are generally for one or two years and are in the form of monetary terms. The consumers goods industries like sugar, cotton, textile, etc. use short-term budgets.

3. Current Budget:

The period of current budgets is generally of months and weeks. These budgets relate to the current activities of the business. Current budget is a budget which is established for use over a short period of time and is related to current conditions.

(B) Classification on the Basis of Functions -

1. Operating Budget:

These budgets relate to the different activities or operations of a firm. The number of such budgets depends upon the size and nature of business.

2. Financial Budget:

Financial budgets are concerned with cash receipts and disbursements, working capital, capital expenditure, financial position and results of business operations.

3. Master Budget:

Various functional budgets are integrated into master budget. This budget is prepared by the ultimate integration of separate functional budgets. The Master Budget is the summary budget incorporating its functional budgets. Master budget is prepared by the budget officer and it remains with the top level management. This budget is used to co-ordinate the activities of various functional departments and also to help as a control device.

(C) Classification on the Basis of Flexibility -

1. Fixed Budget:

The fixed budgets are prepared for a given level of activity, the budget is prepared before the beginning of the financial year. If the financial year starts in January then the budget will be prepared a month or two earlier, i.e., November or December. The changes in expenditure arising out of the anticipated changes will not be adjusted in the budget. There is a difference of about twelve months in the budgeted and actual figures. Fixed budget is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. Fixed budgets are suitable under static conditions. If sales, expenses and costs can be forecasted with greater accuracy then this budget can be advantageously used.

2. Flexible Budget:

A flexible budget consists of a series of budgets for different level of activity. It, therefore, varies with the level of activity attained. A flexible budget is prepared after taking into consideration unforeseen changes in the conditions of the business. A flexible budget is defined as a budget which by recognizing the difference between fixed, semi-fixed and variable cost is designed to change in relation to the level of activity. The flexible budgets will be useful where level of activity changes from time to time. When the forecasting of demand is uncertain and the undertaking operates under conditions of shortage of materials, labor etc., then this budget will be more suited.