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Setting up a budget can be challenging, and so is choosing the right budgeting method that best fits your business’ model and needs. In this article, we will shed light on the five most common approaches to budgeting, as well as their pros and cons. 1. Incremental budgetingIncremental budgeting computes a budget by applying adjustments to the preceding period's actuals. The change typically comes in percentage term and could either be an increase or a cutback depending on many factors, primarily the organisation's needs and situation. To some extent, it helps reflect the growth of the business and changes in the market. Carried through on the basis of historical data, this conservative approach to budgeting is generally preferred by businesses whose cost drivers remain static, suggesting that they manage to maintain a sluggish growth and steady profitability, and are subject to everything from little to no fluctuation or competition in the market, at least until the cow comes home. Read more: Step-by-step guide to developing and managing a budget Given many of this method’s flaws, some have avoided it for good, notably after the Great Recession in 2008. Nonetheless, if businesses find their model is as we described above, they could still reap some benefits from incremental budgeting. Advantages of Incremental Budgeting
Nonetheless, incremental budgeting fails to help companies to stay relevant in this irrelevant world. Read more: What to look for in a planning and budgeting solution Disadvantages of Incremental Budgeting
2. Zero-based Budgeting (ZBB)To create a new budget, zero-based budgeting (ZBB) necessitates the justification of all manner of budget expenditures and line items on the balance statement. On this account, this approach is implemented irrespective of the previous period's spending, as opposed to the above-mentioned traditional method of modifying past actuals. In other words, ZBB compels businesses to build a new budget from scratch; starting from the baseline of "zero" as the name suggests. People in charge, i.e. analysts, will evaluate and justify every bit of expenses. First introduced in the 1970s, as an attempt to align resource allocation and corporate strategy, ZBB is downright a regimented discipline in its earnest effort to justify which activity adds real value and is worth keeping, and which is a futile effort that needs to be disposed of. At the outset, ZBB is structured to optimise cost containment and management, an imperative in this ever-changing world. Aside from that, it is also a value generator that facilitates any number of functions. Advantages of ZBB
ZBB, for all that, has long been a subject of debate as it is undeniably a cost centre that drains resources out of the organisation. Read more: Why keeping a tight control of SG&A expenses may backfire Disadvantages of ZBB
3. Rolling (Continuous) BudgetingRolling budgeting is a rigorous method where people continuously add a new budget period to replace the previous one as it expired. We have discussed this approach and its implication at great length in the last blog post. Advantages of rolling forecasting
Disadvantages of rolling budgeting
4. Activity-based Budgeting (ABB)Activity-based budgeting (ABB) calculates the total cost needed to hit the target of the anticipated level of activities (thus its name). This top-down method first calls for the identification and thorough scrutiny of all the activities that drive cost. This analysis will then give grounds for allocating resources to achieve the level of activities that was anticipated beforehand. To give an example, you run a small toy manufacturer. Your forecast for the next year says that sales would be 10,000 units, each of which is assigned the same Cost of Goods Manufactured (COGM) at $5. Employing ABB, you should compute a budget of $50,000 (10,000 * $5). ABB could be easily confused with ZBB: Rather than starting from the basis of zero, ABB allocates resources by studying the efficiencies of the activity that is under review. Instead of starting everything from scratch, people leverage activity-based analysis to streamline the process. Read more: How Raymond James Financial slashed 50% of its reporting time Advantages of ABB
Disadvantages of ABB
5. Performance-based Budgeting (PBB)Performance-based budgeting (PBB) is another advanced approach where budgets or funds are associated with specific objectives. With PBB, a set of goals or desired outcomes is first set. These objectives will then act as the rationale for the course of activities that the organisation expects to undertake as well as its associated cost. By revolving around objectives, that is, the "results" that the organisation wants to achieve, PBB helps build a result-oriented culture. On a side note, some performance indicators, i.e. KPIs (Key Performance Indicators), are now widely employed to facilitate this practice. Advantages of PBB
Disadvantages of PBB
Stay in touch and get more insights as to Planning, Budgeting and Forecasting by subscribing to our blogs. Topics: Planning and Budgeting, Financial Accounting Management Software What is the best method of budgeting?5 budgeting methods to consider. Which is considered to be the best marketing communications budget method?The Objective and Task method is usually considered as the most sensible and defendable budgeting method. Marketing managers set the budget based on what it will cost to accomplish the communications objectives.
What is a communication budget?Communications budget: This budget is set aside to spread a particular message instead of educating and advertising. This also budgets for personal or one-on-one communications. Marketing and communications budgets can be: Distinct: When your advertising and personal communications do not intersect.
What are 4 methods of budgeting?There are four common types of budgets that companies use: (1) incremental, (2) activity-based, (3) value proposition, and (4) zero-based. These four budgeting methods each have their own advantages and disadvantages, which will be discussed in more detail in this guide.
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