A budget is an important planning tool for every business. The right budgeting method can help you estimate future expenses, revenue, and profits. It can also help you better control your spending and identify situations where your revenue may not be enough to cover your expenditures.
This article will look into 4 top budgeting methods popular with business owners and help you choose one that best suits your business.
Keep reading below to learn more about the most common budgeting methods for businesses.
Budgeting method #1: Incremental budgeting
One of the most popular approaches is incremental budgeting. There’s no fixed formula for incremental budgeting – you simply change last year’s budget by an increment or percentage to obtain this year’s figures.
This method relies on small changes based on actual or budgeted results from the previous period. It’s a good option for businesses with cost-driving factors that don’t regularly change. Without the need for complex calculations, incremental budgeting is the quickest of all budgeting methods.
It’s important to note, however, that your company’s departments may overspend to avoid receiving a smaller budget the following fiscal year. It’s best to look into specific expenditures and spending habits to prevent any kinds of budgetary slack.
Recommended for: Those who are limited on time but need a method that is effective and reasonable. It’s also well-suited if you have an established business with predictable and consistent cash flow and financial activities.
Budgeting method #2: Activity-based budgeting (ABB)
Activity-based budgeting (ABB) is a budgeting method that tracks and analyzes every activity that incurs a cost to identify new cost-saving areas. You can then create a budget based on your findings. Companies typically use this budgeting method to cut expenses, boost productivity, gain a competitive advantage, and improve overall efficiency.
Rather than just using past budgets to determine your new budget, the ABB system digs deeper into the company’s performance and gives you more control over the process. This helps you align your budget with your company’s goals much easier because your budget uses more precise data for its projections. Due to its complexity, the ABB method is more expensive and time-consuming to implement and maintain.
Recommended for: New companies without historical budgeting data. The ABB method is also popular in major industries like manufacturing, construction, and healthcare. It’s also useful for companies that are undergoing significant changes, such as new subsidiaries, large clients, business locations, or products.
Budgeting method #3: Value proposition budgeting (VPB)
Value proposition budgeting (VPB), or priority-based budgeting, is all about driving value. With this method, you go through every cost item to decide whether the value it brings justifies its cost. This allows your business to avoid wasteful spending. One of the main downsides of the VPB method is that value is not easy to determine. This is because it can vary depending on factors such as politics or economic trends. If there isn’t a clear understanding of value, business owners may make short-term decisions that negatively influence long-term goals.
When preparing for the VPB method, businesses have to answer these essential questions:
- Why are we spending this amount of money?
- What value does it bring to our customers and stakeholders?
- Does the value outweigh the cost?
Recommended for: Companies aiming to reduce unnecessary expenses and refocus on customer needs. Government organizations also like this budgeting method because they often experience financial restructuring throughout the year. VPB can help them identify which services are most valuable and most needed within their communities.
Budgeting method #4: Zero-based budgeting (ZBB)
Zero-based budgeting (ZBB) is another common budgeting method. When applying the ZBB method, you assume that all department budgets are zero and must be rebuilt from scratch. In other words, past budget numbers are not considered. Budget planners must justify every penny spent. The ZBB method is very strict, attempting to eliminate any expenses that do not contribute to the company’s profit. It’s difficult and time-consuming to carry out a zero-based budget, so many companies only use this approach on occasion.
Recommended for: Businesses that have an urgent need to reduce cost, for example, during a financial restructuring.
What are other types of budgeting methods for businesses?
According to the Corporate Finance Institute, “participative budgeting is a budgeting process in which the people who are in the lower levels of management are involved in the budget preparation process.”
This method gives managers who are closer to, and more knowledgeable about, specific parts of the business the ability to share their input on a budget. Not only is this more efficient, it also improves employee morale because it provides them with a “sense of ownership” of the business.
Recommended for: Medium to large-sized businesses whose higher-level managers may not have direct experience with all departments.
According to the Corporate Finance Institute, ”bottom-up budgeting is a budgeting method that starts at the department level, moving up to the top level.” This is very similar to participative budgeting, however there are a few key differences.
Bottom-up budgeting relies on each department to submit their own budgets, which are then factored into the overall company budget. To do this, every department is first required to determine their cost projections, which are then used to create their budget.
The final budget combines all of these budgets. This is then submitted to upper management for approval.
Recommended for: Businesses looking to empower lower-level employees and create highly-accurate, well-balanced budgets.
Frequently asked questions
1. GnuCash—This is an open-source accounting software that not only helps you with budgeting, but also with other areas of accounting management, such as invoicing, customer management, and more. This software can be a little tricky to get started, but there are plenty of online tutorials and a manual that you can refer to.
2. Capterra offers a comprehensive budget template that works with Excel. This template can be used to create both your monthly and annual budgets, as well as compare numbers and view overall performance. They also offer guides to help you through the process.
3. Excel fans will love PDFConverter.com’s list of 15 Excel Templates for Small Business Budget Management. The list includes templates for everything from business trip budgeting to expense budgeting.
4. Google Sheets has its own budget template, developed by Intuit Quickbooks, which can be found in its Templates Gallery.
5. Microsoft Office has an expense-focused budget template that also does some basic reporting by generating charts and graphs based on the information you input.
Budgeting can be stressful, especially if you’re doing it on your own. As a small business owner or freelancer, you don’t have the luxury of relying on your finance team to create your budget. We’ve compiled a list of guides you can reference to improve your business budgeting skills.
1. FreshBooks has a great 5-step guide to creating a business budget.
2. If you’re struggling to decide whether to invest in budgeting software, Relay has put together a list of 18 budgeting software and tools for small businesses.
3. Check out this short but sweet list of 6 tips for a better business budget by Investopedia.
4. For a more comprehensive guide, Smartsheet has put together the ultimate guide to small business budgeting.
5. We recommended keeping track of your expenses by digitizing your receipts, invoices, and other financial documents. Shoeboxed has put together a complete guide to receipt organizing and management.
6. Lastly, knowing what you can safely write off will mean more cash in your budget for other necessary expenses. Check out these commonly missed tax write offs!
Employing a suitable budgeting method for your business is an effective way to save costs, increase productivity, and bring in more profits.
By understanding the basics of commonly-used budgeting methods among businesses, you can gain a deeper insight into your own business’s situation to improve your financial performance.
In order to determine your ideal budgeting method, it’s important that you have accurately recorded expenses. Shoeboxed can help with that.
Shoeboxed is a well-trusted tool to help businesses, freelancers, and DIY accountants store and organize their receipts.
The app automatically extracts, verifies, and categorizes important data from your receipts, then stores them securely in the cloud. Most importantly, scanned documents from Shoeboxed are accepted by the IRS.
Originally published on April 6, 2022. Updated on September 17, 2022.
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