Businesses use different types of budgets to allocate resources for the year. Some still follow the traditional approach, while others have moved on to modern-day budgeting methods.
How you create your budget has a direct impact on your business performance. A strategic budget focusing on crucial areas can cut costs and give you a competitive advantage.
Consequently, an ill-planned budget can result in waste and take a toll on your bottom line.
Today, we will explore the common budgeting approaches you can use for your organization. You will also learn how to pick the right one for your needs.
Standard Types of Budgets
Here are the common budgeting approaches you can adopt to create your budget:
This form of budget uses your last year’s figures as the foundation. You then change the numbers to suit the conditions of the current year. Specifically, you look at the costs and revenues of last year and adjust them based on factors like market demand, inflation, change in prices, and so on.
The traditional budget takes less time to prepare, and only a few figures need justification. However, it can be a bit rigid and averse to change.
Incremental budget is quite common and used by many businesses. You base your current budget on last year’s numbers and adjust them to account for your projected growth or decline.
Let’s say your organization has projected a decline of 5% for this year. So, you reduce your budget by 5% across your organization to account for the change.
Incremental budgeting is fast but not very accurate. You can spend money without deriving value as you aren’t justifying but only adjusting your expenses.
Zero-based budgeting takes zero as the starting point without any consideration for last year. Every department will get new resources based on the needs of the current year. You will need to justify each item in your budget, which can be time-consuming.
However, you can get the most accurate budget using this method.
An activity-based budget ensures your allocation of resources aligns with your business goals. This type of budget focuses on what you want to achieve in the current year.
Let’s say you want to increase your sales by 10%. So, you will need to determine the cost drivers you will require to boost sales by 10%. You can then create your budget, taking into account all those cost drivers.
What Types of Budgets are Best for Your Business?
You have multiple types of budget to use for your organization. However, how do you know which one will suit your needs?
First, start by weighing the pros and cons of each method of budgeting. Along with that, consider the following:
- Your business size
- Areas you operate
- Your business objectives
- Market competition
- Available data for creating your budget
Analyzing each budgeting method based on the above factors will help you choose the right one for your needs.
Let’s say you want to cut production costs and waste across your department. So, you can choose the activity-based budget that aligns your budget with your business objectives.
Alternatively, let’s say you are dealing with tough competition. Here, zero-based budgeting can come in handy to justify each cost and explain the need.
You can also rely on an activity-based budget to gain a competitive edge in your industry.
Is Traditional Budget Still Relevant?
Traditional budgets, including incremental budgeting, take less time and resources to prepare. They are suitable for industries that experience fewer fluctuations in demand, price, or competition.
As a result, traditional types of budgets are good for businesses that are not affected by change.
However, almost no organization is a hundred percent resilient, which has been proved recently by COVID-19.
Therefore, businesses will benefit from modern types of budgets to achieve operational efficiency and stay agile to changes.
Your budget has a direct impact on your bottom line. As a result, you need to carefully pick out the best approach to prepare your budget. Focus on your business requirements and consider factors like competition to decide what is best for your needs. You may also want to consider your available resoaurces, as methods like zero-based budget need time and labor.