A company’s annual financial plan is called a budget. In short words; a budget is a set of pro-forma statements about the company’s finances and operations. Before a company or other organizations can develop operating budgets, management must decide what planning approaches to budgeting will be used for the various revenue and expenditure activities and organizational units. What are the four approaches?

A budget is a tool for both planning and control. At the beginning of the period, the budget is a plan or standard; at the end of the period, it serves as a control device to help management measure the firm’s performance against the plan so that future performance may be improved.

The budget itself is classified broadly into two categories: the operational budget, which reflects the results of operating decisions; and the financial budget, which reflects the financial decisions of the firm. The operating budget consists of: (a) Sales budget; (b) Production budget; (c) Ending inventory budget; (d) Direct materials budget; (e) Direct labor budget; (f) Factory overhead budget; (g) Selling and administrative expense budget; and (h) Pro forma income statement. So what are the four planning approaches to the operating budget? Widely used planning approaches to budgeting include the input/output, activity-based, incremental, and minimum level approaches which are discussed through this post. Read on…