Continuous budgeting definition
/What is Continuous Budgeting?
Continuous budgeting is the process of continually adding one more month to the end of a multi-period budget as each month goes by. The continuous budgeting concept is usually applied to a twelve-month budget, so there is always a full-year budget in place.
If a company elects to use continuous budgeting for a smaller time period, such as three months, its ability to create a high-quality budget is greatly enhanced. Sales forecasts tend to be much more accurate over periods of just a few months, so the budget can be revised based on very likely estimates of company activity. Over such a short period of time, a continuous budget is essentially the same as a short-term forecast, except that a forecast tends to produce more aggregated revenue and expense numbers.
Advantages of Continuous Budgeting
This approach has the advantage of having someone constantly attend to the budget model and revise budget assumptions for the last incremental period of the budget. If continuous budgeting principles are applied to capital budgeting, this means that funds may be granted for large fixed asset projects at any time, rather than during the more typical once-a-year capital budgeting process that is prevalent under more traditional budgeting systems.
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Disadvantages of Continuous Budgeting
The downside of this approach is that it may not yield a budget that is more achievable than the traditional static budget, since the budget periods prior to the incremental month just added are not revised. Another concern is that the period of this budget may not correspond to a company's fiscal year.
Continuous budgeting calls for considerably more management attention than is the case when a company produces a one-year static budget, since some budgeting activities must now be repeated every month. In addition, if a company uses participative budgeting to create its budgets on a continuous basis, then the total employee time used over the course of a year is substantial. Consequently, it is best to adopt a leaner approach to continuous budgeting, with fewer people involved in the process.
Example of Continuous Budgeting
Pho Fashion is a women’s clothing company whose sales are subject to the whims of consumers. Because of this demand variability, the company’s budget director routinely uses continuous budgeting to keep the firm’s financial planning models as up-to-date as possible. To do this, the budget director uses a rolling 12-month time frame, where her staff extends the budget model by one month, as soon as the most recent month has been completed. For example, Pho has just completed the month of February, so the budget director’s team appends a budget for the month of February in the next year to the existing budget model. The appended period replaces the February budget for the period that has just passed.
As part of the process of devising a new budget period, the budgeting team considers changes in the firm’s market conditions, customer acceptance of its products, anticipated sales for new product roll-outs, and other factors that may impact financial results. The team also considers the impact of bottlenecks on its ability to generate sales, and the need for investments in more infrastructure to support its projected sales and production activity. For example, they may decide that a new women’s casual line will be a hot seller, which will require a greater investment in working capital to fund the inventory needed to meet projected customer demand.
By using this continuous budgeting model, Pho Fashion can continually adjust its financial models based on the latest market conditions, allowing to to allocate resources more efficiently to those areas that are likely to be most in need of additional investments, while scaling back on those areas that do not.