Traditional Budgeting

Updated July 10, 2023

Definition of Traditional Budgeting

Traditional budgeting is quantitative financial planning done by the company’s accountant today for the future. Traditional budgeting is done by taking the past figures from last year’s company’s budget.

This method is very easy to use and is used by most businesses to forecast their expected profits or losses. Traditional budgeting is also a type of routine work for most of the accountants in the company.

Traditional Budgeting Process

The traditional budgeting is done by taking the last year’s figure as a base. The process helps in calculating the projected sales/revenue for the company. First, the accountant calculates the budgeted figures for the current year by giving the effect of inflation prevailing in the market. After that, they analyze the last year’s expenses and some expected expenses to be borne this year. In this way, the budgeted expenses are found. When all these things are done, they determine the company’s expected profit or losses. In big companies, there are several departments; therefore, each department presents its budget, then it is presented by combining the departments. The process helps the management to make further decisions on the improvements and also on the cutoff of any expenses which is unnecessary.

Example of Traditional Budgeting (With Excel Template)

Let’s take an example to understand the calculation of traditional budgeting in a better manner.

Example

Indigenous Limited is a manufacturing concern and wants the accountant to prepare a Budget for this year.

• Sales: $5000 for the last year, considering inflation of 5% this year.
• Direct Material cost: 30% of sales and inflation 2%.
• Direct Labor cost: 50 workers @ $15 to be considered the same as last year.
• Overhead: $500 was last year’s overhead; a 7% increment is expected this year.
• Repair and maintenance: $40, same as last year.
• Administration cost: $60 was last year’s cost; this year’s increment of 50% is expected.
• Miscellaneous expenses: $15 is expected this year.

Solution:

Budget for the Year

Therefore it is expected that the company will earn a profit of $2290 this year.

Advantages

Some of the advantages are given below:

• It is done by considering the accounting aspect. All the overheads and expenditures are to be considered very accurate.
• Traditional budgeting is very easy to prepare no expert is required to implement the same.
• It mainly focuses on the last year’s figures.
• It is prepared by taking the last year as the base year. Inflation is also considered in this method. Therefore realistically budgeted financials can be produced.
• Traditional budgeting is done for the top management. The top management gets a clear picture from the Budgeted figure and can make necessary decisions.
• It is also considered normal routine work for most businesses. Therefore, they make their monthly targets in such a way that they can earn maximum profits.
• It is also very easy to understand that no such expertise is required to budget for this process.
• In Traditional Budgeting, the entire department is cumulated. Therefore, the profits and losses are seen on an overall basis.
• Traditional budgeting also makes the financials of the company very clear. The accountant is keener toward the profit or loss rather than the company’s performance by measuring the input and outputs.
• It also brings stability to the functions of the company. It gives a clear picture of how much and when to invest.

Disadvantages

Some of the disadvantages are given below:

• In Traditional Budgeting, the base year is the last, and all the calculations are done in manners that are not always realistic.
• The priority is always given to the past budgeted figures while preparing the Traditional Budgeting. However, it has been seen that some managers can adjust this traditional budgeting process because they can easily alter the figures since it is not specific to budgeting. Therefore the company management can present the company’s budgeted financials to their stakeholders the way they like to.
• In the case of Traditional Budgeting, the process is designed so that excessive reliance will be on the past year’s figures.
• It is a routine task that is done in a very regular manner. If any query arises, management does not go for any investigation in this type of Budgeting process.
• It is also an overall budgeting process. It includes all the department’s overall budgets cumulatively shown under one heading. This is a good practice for small businesses. Still, for big businesses with lots of transactions in different departments, it isn’t easy to show all the budgeted figures cumulatively. Thus, this traditional budgeting is not proper for big business units.
• Due to this cumulative reporting, some wasteful expenditures are not eliminated because the management does not easily identify them.

Conclusion

Traditional budgeting determines the budgeted figures for the next year so that management can make important financial decisions. It is an overall analysis of the budgeted figures. The Traditional Budgeting is prepared by considering the last year as the base year, and then inflation is imposed. In the worst-case scenario, the management team managers manipulate the next year’s budget; they may show profit or loss per their requirements.

But because traditional budgeting is very useful and effective for small businesses, it is not always recommended for the big business units because, in the big business unit, there are lots of transactions going on each day. Thus, department-wise performance should be analyzed. Moreover, It has a very limited scope regarding the overall projection for the company. So nowadays, in big organizations, department-wise budgets are prepared for effective planning, control, and evaluation.

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