The types of budgeting method you apply to your business planning depends on your situation. There is more than one way of thinking about budgeting. Essentially, more than one way to approach it. Let us explore some of the different budget methods that are commonly used. And, then show you how you do the budgeting in Calxa.
It’s not about picking the budgeting methods that are right or wrong, more the ones that suit your type of organisation or the situation you are currently in.
1. The Incremental Budgeting Method
Incremental budgeting is based on making small changes from the actual or budgeted results for the preceding period. It is perfect when there are only minor changes to your business or its environment. Above all, it is the quickest of all the budget methods. Thus, it is well-suited to those who are short on time but need something quick and reasonable.
Calxa’s Budget Factory is the perfect tool to use for an Incremental Budgeting Method. It takes actuals or budgets from one year and projects them forward. You can make different incremental increases or decreases year by year on:
- Cost of Sales
- And Expenses
Even if it is not the final result, it’s often a good starting point for many organisations.
2. The Zero-Based Budgeting Method
The concept of the Zero-based budget is diametrically opposed to the Incremental budgeting method. It is a type of budget that starts from the detail on each account for each month and requires detailed justification of every amount.
Zero-based budgets are a valuable tool in a financial crisis where cost-containment is vital for the survival of the organisation.
Firstly, while many costs are fixed in the short to medium term, many others are discretionary. And, secondly, evaluating and assessing the contribution these costs make to the success of the organisation focusses the minds of managers. In particular, it targets what is really important and what can be discarded or postponed.
However, using the zero-based budgeting method can be hard work. Mostly, it is a process that needs regular discussions with all the people involved. In other words, they need to be connected to the area of the business to fully understand the business case for each expense. You will find history is full of examples of external consultants employing a zero-based method without fully understanding the business needs. Ultimately, this can cause long-term damage to the business survival.
Zero-based budgets can be built in Calxa using a combination of Metrics. Ideally, these are the drivers of each expense or income line. Then you simply use formulas to calculate the results. Read this article How to Calculate Payroll Budgets on how to use metrics in this kind of situation.
3. The Activity-Based Budget
Another commonly used budgeting method is the Activity-Based budget. In particular, this budgeting method has been traditionally associated with manufacturing processes. However, the concept is applicable to many businesses.
Essentially, it requires looking at the main activities in an organisation and then identifying the drivers of both revenues and costs for those activities. Usually, this is not as detailed as a Zero-Based Budget. Therefore, the focus is on the main activities that drive revenue, not on overheads and administration. Often, this can be a popular budgeting method for not-for-profits and NDIS service providers.
Because it uses the cost drivers of each process, activity-based budgets can be useful in assessing the pricing and profitability of different products or activities. This is particularly helpful to an organisation in making judgements on which parts of the business are more important to expand or allow to contract.
4. The Negotiated Budgeting Method
Traditionally, budgets have originated with senior management or the top level of the finance department and then been distributed to department and project managers as a fait accompli. It is much more common in the 21st century for senior management to provide top-level guidelines to department managers. They then have freedom to determine the distribution of expenses within their area.
Calxa users can easily implement the Negotiated Budget method either by exporting and distributing draft budgets or by giving department manager access to Calxa to edit their own budgets. In addition, the finance manager can then verify that they are within the guidelines and incorporate them in the overall budget.
The theory is that each department manager knows best what is required in their area. However, senior management maintains responsibility to ensure the organisation as a whole survives and thrives.
5. The Participative Budget
The Participative Budgeting method extends the principles of the Negotiated Budget. One difference is that it starts at the other end. Budgets begin with department or project managers. After that, they are then fed up the chain to be combined into an organisation-wide budget. The benefit is that managers have more responsibility and ownership of the budgets in their areas. Therefore you will find there is more commitment to achieving the goals associated with them.
A Participative Budget works best in Calxa when each manager can directly enter their own budget. This can then be reviewed and revised by the finance team to ensure it fits within the organisation goals.
Combine Budgeting Methods for Best Outcomes
There are no right or wrong budgeting methods here. The best method is the one that works for you. In other words, it is the one that gives you the best budget for the least effort.
The culture in your organisation will determine whether you are better to work with a Negotiated or Participative Budget. Within these you may use a combination of Incremental or Zero-Based Budgeting methods.
Budgeting Methods in Summary
In short, here is a quick summary on all budgeting methods for you to consider.
- For fixed costs, the Incremental Budget works well as there is little short-term discretion with them.
- On the other hand, Zero-Based or Activity Budget is good for new projects or for a major review of something existing.
- Whilst the Participative Budget method will give maximum ownership to your team, the Negotiated Budget balances gives ultimate control to management to execute their responsibilities.
The important thing is to do some sort of budget. Set some goals so you can measure your performance at the end of the year.