The methods of budgeting that are most often employed include:
- constant budgeting;
- budgeting based on activities;
- zero-based budgeting.
We’ll go into more depth below about each’s advantages and disadvantages.
Constant (Incremental) Budgeting
The incremental budgeting approach is arguably the most popular. It is easy to use and can be applied to nearly anything, including departmental budgets, project budgets, and wages, provided that the activity has been done before.
When creating a new or current year’s budget, incremental budgeting includes adding to or subtracting from the prior year’s actuals by an amount or percentage.
If your firm is established and you are certain that the budget will be consistent over time with only minor modifications, an incremental budget is most beneficial.
Are you a start-up in a relatively new field hoping to establish yourself or disrupt an existing category? When your expenditures change annually while you try to find a market for your product, you might want to think about using a different budgeting strategy.
Budgeting incrementally benefits:
- needs no intricate computations. use current figures and makes adjustments to reflect inflation or revenue growth;
- because of how easy it is to develop and compute, it saves time;
- over time, the budget can stay mostly constant;
- aids in financing stability because annual costs are straightforward to forecast;
- less interdepartmental conflicts since the budget typically allocate equal incremental improvements across the board.
Cons of incremental budgeting:
- as a result, spending more money than necessary may result;
- does not take into account unanticipated changes or other variables;
- this could deter management from investigating costs and savings in further detail.
Budgeting Based on Activities
Business activities that incur costs are found, examined, noted, and forecasted using activity-based budgeting. Every operation that has a cost is looked at for opportunities to improve efficiency and profitability. A company can do this by decreasing activities, removing pointless operations, or lowering expenses for pertinent cost drivers.
Activity-based budgeting might be an excellent option for a start-up or new business since you lack the historical data needed for other approaches, such as incremental budgeting.
Traditional budgeting is preferred by well-established businesses, nevertheless, as it involves less time, money, and effort to complete than activity-based budgeting and is frequently simpler to compute.
Activity-based budgeting is appropriate for organizations going through significant operational changes, in addition to emerging businesses. A significant change in the locations of important exporters and importers or the introduction of a new business line are a few examples of these.
Pros of activity-based budgeting:
- improved understanding of operating expenses;
- focuses on actions that bring value;
- reduces pointless actions to reduce expenses;
- better decision-making as a result of more clearly stated costs;
- owing to a top-down methodology that allocates resources by a desired outcome or aim.
Cons of activity-based budgeting:
- a protracted and long-consuming procedure where analysis can take up too much time;
- expertise in budgeting and financial planning is needed to identify any gaps or overlaps;
- this could cause people to ponder just briefly, losing sight of the broader picture as a whole;
- if the outcomes don’t turn out as expected, forecasting may not be accurate. If the budget isn’t carefully thought out, this might result in significant cash flow problems.
Zero-Based Budgeting
With zero-based budgeting, each year’s budget is created from scratch. With this budgeting strategy, managers must create their budget categories and items and justify each spend without consulting the figures from the prior year.
Zero-based budgeting takes time since budget owners have to justify every item that is being suggested.
However, it’s a terrific approach to cut down wasteful spending and identify essential charges for the business. When a company has to cut expenditures immediately, zero-based budgeting is another option. For instance, your company may need to drastically cut the budget due to a financial reorganization.
Pros of zero-based budgeting:
- a great method to cut back on unnecessary expenditure;
- holds management responsible for expenses and actively reduces bloated budgets;
- reduces any negative effects on operations while assisting in cost control.
Cons of zero-based budgeting:
- a long-consuming process that needs resources, time, and approval;
- rewards short-term, tactical thinking above long-term, strategic thinking;
- to provide their departments with greater resources, some managers could try.