In the last blog, we have given an introduction on different budget approaches, Top Down v Bottom Up. The budget approach looks at budget from whom is leading the budget process. Today we will look at different budget types, which observes budget from which methodology is used in the budget process.
There are various types of budgeting with various names. Some are more suited to one type of business than the other. Here we will look into some most common ones:
- Activity based budgeting
- Flexible budgeting
- Rolling budgeting
- Incremental budgeting
- Value based budgeting
- Zero-based budgeting
Activity Based Budgeting:
This is a top-down budgeting approach that determines the amount of inputs required to support the target or outputs set by the company. Activity-based budgeting (ABB) is a system that records, researches, and analyses activities that lead to costs for a business. Activity-based budgets are more than merely adjusting previous budgets to account for inflation or business development. Instead, ABB searches for efficiencies in business operations and develops budgets based on these activities. Activity based budgeting is a long exercise to find our cost of each and every activity in a large organization and assess the value addition of the same. This exercise also includes alternative procedure to perform the same activity or reaching to the same goal while reducing the cost.
When a company faces so much variations in terms of their sales and costs, Flexible Budgeting could be a better option. Since a flexible budget model allows to use various sales levels in the model, and the costs get adjusted accordingly. This budget model is also useful for growing companies where it is hard to estimate the costs and sales especially for the first few years of the business. However, this may not always be possible to prepare a budget based on this method due to the lack of expertise and resources available in a company.
The Rolling Budget:
A rolling budget requires that a new budget period be added as soon as the most recent period has been completed. By doing so, the budget always extends a uniform distance into the future. However, it also requires a considerable amount of budgeting work in every accounting period to formulate the next incremental update. Thus, it is probably the least efficient budgeting alternative compared to other types, although it does pay ongoing attention on the budget.
This type of budgeting is more popular among the organisations that are matured and not expecting tonnes of changes in their business operation in the foreseeable future. This can also be good for companies who can only invest limited resources to prepare the budget modelling. As the name suggests, Incremental Budgeting only takes into account the small changes made to the previous period budget based on the forecasts for the current year.
Value Based Budgeting:
Budget Director or the person responsible will be analysing and monitoring every expense type to ensure everything included in the budget delivers value. This budget modelling usually asks the below three questions:
- Why is an element included in the budget?
- Does the item help to maximise shareholders value or any other stakeholder value for that matter?
- Does the benefit outweigh its cost? If not, can this be justified for any other reason?
Zero Based Budgeting (ZBB):
Zero Based Budgeting is built from scratch and more used where there is no past data available. In this budgeting type, budget holder must be able to justify each and every expense type. Any expenditure which cannot be established as an essential element for the budget, will be removed. This type of budget is more popular among Government and not for profit organisations. This can also serve well when a company is going through restructuring and / or need to contain costs. As it will produce a budget considering the current situation regardless of the past.
As we have cover different types of budgeting, you might be wondering which one you should adopt in your business. We recommend that you take a look inside of your business to understand your business operations, culture, and future goals. Or you can speak to your business mentor or a professional business consultant to help you assess and make a choice. Every business is different and may be in different stages of its lifecycle. So, it is not which type is best, but figuring out which type is best suited to your current business is crucial.