What is a rolling budget? Pros and Cons of using it
Rolling budgets are becoming very popular among businesses. The concept of rolling budgeting is influenced by a movement named ‘beyond budgeting’ that believes that companies can manage without budgets. The idea is to critically analyze revenue and costs every now and then rather than projecting the figures a year in advance. And that’s exactly what rolling budgets do. With a rolling budget, you always have a current budget at your disposal.
What is a Rolling budget?
A rolling budget, also known as a continuous budget, is a budget that is updated continuously in each accounting period when a portion of the overall budget period has elapsed.
A portion of the budget period that has lapsed is replaced with an equivalent period so that the total period remains unchanged. This is done on a regular basis to ensure continuity in the budgeting process.
This will be clearer with an example. Suppose your budget period is one year. Now with a rolling budget, when one quarter concludes, you add a new quarter to the end of the budget period and the elapsed quarter could be removed. This way, your budget is always looking one year ahead.
The rolling of periods could be monthly also. Assume a company, that closes its books on 31st December each year, follows a 12-month planning horizon, and its initial budget is covering the months of January 2021 to December 2021. As a month passes, the January period is over, so now the company adds a budget for the following January (i.e. January 2022) while eliminating the statistics for the month just passed (i.e. January 2021). By doing so, it will still have a 12-month planning horizon that extends from February of the current year (2021 in this case) to January of the next year (2022 in this case). Likewise, at the end of February 2021, the rolling budget will drop ‘February 2021’ and will add ‘February 2022’. At this point, the rolling budget will cover the one-year duration of March 01, 2021 through February 28, 2022.
During the process, if any significant variances are noticed between actual and budgeted results of a month just ended, such variances are analyzed in detail and accordingly, the budgets for all the remaining months are adjusted, in addition to adding the details of a new month. This process is repeated each month on updating the figures. For instance, if results of January 2021 depict that prices of materials have increased by 2.5% due to a change in the supplier’s contract, then such rise in costs will be adjusted in figures of all the remaining 11 months, alongside adding the costs for January 2022 based on these revised material prices.
In contrast to the traditional approach of budgeting that is sometimes criticized for having fixed targets (usually yearly), rolling budgets bring in more flexibility to the process of planning. Such budgets could be rolled over every month, quarter, or even fortnightly.
The objective of rolling budgets is to anticipate the risks and opportunities that a changing business environment presents, revisit strategy in light of new business scenarios, and align resources/activities for competitive advantage at periodic intervals. (source)
A rolling budget moves at a much faster pace to reflect the ever-changing business climate, allowing one to navigate the business as conditions change. It is more adaptable and flexible as it allows a business to react to financial changes in ways that a fixed, traditional budgeting approach cannot. This is so because a traditional budget is usually a fixed annual budget that does not change throughout the year. (source)
Suitability of rolling budgets
A rolling budget is majorly used in situations when long-term future costs and/or business activities are not capable of being forecasted accurately due to the fast-changing environment. That is why a rolling budget sets to adjust or replace a portion of the budget cycle on a regular basis, assuming the costs would somewhat be easier to estimate for this shorter period (or portion).
Moreover, a rolling budget is apt for any area of business that requires constant monitoring. For example, because of the necessity to maintain tight control over this area of financial management, a cash budget is typically a rolling budget. The approach of rolling budget is also used for making sales, production, overhead, or other financial budgets.
Process of rolling budget
1. Prepare a budget for each month of the year (say January – December).
2. At the end of each month, assess performance results, noting variances between estimates made and the actual revenue/expense.
3. Based on the assessment of these variances, revise the budget for the rest of the months
4. Add on the statistics for another month (January of the next year), so that the company has a full one-year plan again.
5. Repeat the process every month.
Given below is a sample format of a rolling budget (only for reference purposes):
Advantages of rolling budgets
Some benefits of using rolling budgets are:
- Planning and control will be based on a current plan which is likely to be significantly more practical than a preset annual budget set months ago.
- Because they concentrate extensive planning and control on short-term prospects where the degree of uncertainty is significantly smaller, rolling budgets lessen the factor of uncertainty in budgeting. They give an accurate and logical bend to the budgeting procedures of a company.
- When rolling budgets are adopted, managers have to rethink the process (or expense allocations) and make changes each month or each period. They compel managers to reassess the budget on a routine basis and to produce budgets that are updated in light of current events and expectations. Thus, rolling budgets enable a business to respond quickly to current events.
- Rolling budgets, as they show a realistic picture, will exert a better influence on managers and motivate them to achieve targets.
- When a company has rolling budgets in place, it always has a target to look up to for several months to come. Suppose if rolling budgets are updated every quarter, there will always be a budget ready for the coming 9 to 12 months. This helps to have a timely and more realistic planning process, together with allowing the management to plan for contingencies. However, this is not the case when usual annual budgets are fixed, in which case, you have to wait for a full year to have the budget ready for the next year.
- The preparation of traditional budgets normally begins in the third or fourth quarter of a year to set the estimated figures for the next whole year. Once a budget is fixed, it is not changed. While in the case of traditional budgeting, there is a specific duration during which planning is executed, rolling budgets are updated continuously. Thus, by overcoming the weaknesses of traditional budgeting, rolling budgets help an organization stay abreast with the current information, speed up the decision-making process, and also promote value-added activities. (source)
- Staying current with a budget allows businesses to respond faster to potential changes, capitalize on opportunities that were not available when the budget was originally created, and avoid problems that have arisen since. In the event of a significant change in revenue or expenses, the company can incorporate the change into the rolling budget.
Disadvantages of rolling budgets
There are some negatives of using rolling budgets too. Some of these are:
- Rolling budgets often need more time, effort, and money for their preparation. Especially, the accounts department of a company is required to put in large efforts in revising costs and stock valuations each time a rolling budget is prepared. Therefore, before adopting a rolling approach, every company should check whether it has the time and resources to prepare plans on a more frequent basis.
- Preparing budgets at frequent intervals – one after the other can generate feelings of annoyance or discomfort among managers. They may start to dislike the company’s budgeting process and might find it disturbing too. Moreover, employees can also feel de-motivated if the budgeting targets keep on changing frequently.
- Increased emphasis on budgeting work can lead to increased responsibilities and pressure at work. This, in turn, may cause a company to have less control over the actual processes & results. It may be too busy in evaluation that it could lose control over its actual operations.
- Updating budgets on a regular basis can also create confusion in the numbers that a business is working towards.
Rolling budgets focus on continuous improvements, as the budgets are constantly updated for any adjustments from time to time. But this may not be suitable for companies that function under stable conditions. They are more suitable to industries impacted by a rapidly changing external environment, e.g. IT industry or the marketing industry.
In addition, rolling budgets are usually updated every month. Nevertheless, a business may also have a 5-year rolling budget for capital expenditures. In this case, a full year will be added to replace the recently completed year. Because of this 5-year rolling budget, management will always have a 5-year planning horizon.
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