Budgeting is a basic component of any business. Without budgeting, you cannot know how much you can afford to spend or estimate the revenue possible. Different budgeting techniques allow you to approach budgeting in the way that makes the most sense given your business objectives and circumstances. It is not unusual for a company to occasionally switch budgeting methods if its financial needs shift, as each method has advantages and disadvantages.
Traditional budgeting takes budget data from one year's budget and uses it as a foundation for next year's budget. Under this method, you must justify only the incremental changes that occur between the previous budget and the current one. This form of budgeting requires that you view everything aside from the incremental shifts as fundamental to business operations. For this reason, traditional budgeting also is called incremental budgeting. One advantage of this method of budgeting is that a significant amount of the information is simply carried forward from the previous year's budget. Distinguishing between the basic expenses and incremental changes also focuses attention on where the company or market is changing, which is useful for noting trends.
Zero-based budgeting is essentially the opposite of traditional budgeting. With this method, you must start from scratch every time you make a budget. You do not pull any data from the previous year. You also justify everything in the budget, not just incremental changes. Because you must start with fresh data, zero-based budgeting requires a considerable amount of time. It is advantageous, however, in that you may add or delete items from the budget easily from year to year. It also means you take current market conditions into consideration every time for every item.
Activity-based budgeting estimates the cost for each activity that will occur in a business. Using this method, you formulate the budget based on an analysis of those costs. The major advantage of activity-based budgeting is that the relationship between the cost of operations and the company's objectives are very clear. It also gives you a chance to look at the results you achieve given the funds you allot to specific activities. This means it is a highly effective budget method to use when a company wants to focus on how you are managing the business.
Priority-based budgeting requires you to make a list of all the items you would like to include in the budget. You organize the listed items in order from the most essential to the least essential. You do not need to start from scratch with this budgeting system, although you may if desired. With this type of budgeting, departments essentially compete for the funds available. This is good in that it requires departments to think critically about how they defend their budget requests.
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