What are Types of Budgeting Models?

Types of Budgeting Models

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Types of Budgeting Models

Budgeting is a critical aspect of financial planning, whether for individuals, businesses, or governments. Over time, various budgeting models have been developed to cater to different needs, complexities, and objectives. Here are some common types of budgeting models:

  • Incremental (or Traditional) Budgeting:
    • Based on the previous period’s budget or actual performance.
    • Adjustments are made for the new budgeting period by either adding to or subtracting from last period’s figures. It’s a simple and straightforward method but can perpetuate inefficiencies.
  • Zero-Based Budgeting (ZBB):
    • Every item in the budget starts from a “zero base,” and each function or expense must be justified for every new budget period.
    • It’s a more rigorous approach than incremental budgeting and is designed to allocate resources more efficiently.
  • Activity-Based Budgeting (ABB):
    • Derived from activity-based costing (ABC), it budgets by associating activities with costs.
    • The budget is set based on the expected costs of the activities necessary to achieve the budgeted output.
  • Value Proposition Budgeting:
    • Focused on funding things that provide the most value.
    • Requires a clear understanding of the value provided by different activities or expenditures.
  • Rolling (or Continuous) Budgets:
    • As time progresses, the budget period “rolls” forward.
    • For instance, as one month ends, a budget for the same month in the following year is added, ensuring a constant 12-month budget horizon.
  • Performance-Based Budgeting:
    • Resources are allocated in alignment with set performance goals or targets.
    • Aims to improve the efficiency and effectiveness of operations.
  • Program-Based Budgeting:
    • Budgets are designed around the different programs or projects of an organization.
    • Each program has its own budget, showing the resources allocated to it and its expected outcomes.
  • Flexible Budgeting:
    • Provides different budgets for different levels of activity.
    • Useful when costs are difficult to predict, as it allows for adjustments as activity levels change.
  • Capital Budgeting:
    • Used for making decisions about investments in long-term assets, such as equipment, machinery, or new products.
    • It involves evaluating the profitability or returns of these investments.
  • Cash Flow Budgeting:
    • Predicts an organization’s cash inflows and outflows over a specific period.
    • Crucial for ensuring liquidity and successful operations.
  • Static Budgeting:
    • A fixed budget that doesn’t change regardless of actual operational performance or changes in activity levels.
    • Can be problematic if there are significant deviations from what was predicted.
  • Participative (or Bottom-Up) Budgeting:
    • Involves multiple layers of an organization in the budget creation process.
    • Typically, lower-level managers create their own budgets, which are then aggregated and approved by higher-level managers.

The choice of budgeting model often depends on the nature of the entity, the complexity of its operations, its strategic objectives, and the specific challenges it faces. Proper budgeting can greatly enhance financial discipline, operational effectiveness, and strategic decision-making.

Example of Types of Budgeting Models

Let’s delve into three of these budgeting models using hypothetical examples to clarify how they work in practice:

Company: FreshBite Foods, a company that manufactures and sells organic snacks.

1. Incremental Budgeting:

  • Last Year: FreshBite Foods had a marketing budget of $100,000. They used this budget for advertising campaigns, promotions, and other marketing activities.
  • This Year: Given a predicted 5% increase in sales and a similar rise in other costs, the company decides to increase the marketing budget by 5%. Thus, this year’s marketing budget will be $105,000.

2. Zero-Based Budgeting (ZBB):

  • Scenario: FreshBite Foods wants to re-evaluate all of its expenses to ensure efficient allocation. They decide to use ZBB for their office supplies budget.
  • Process: Instead of using last year’s expenses as a starting point, the office manager must justify every single expense. They present a detailed plan, explaining why each item (like paper, printer ink, coffee, etc.) is needed and in what quantity. The budget is then set based on these justifications. This might lead to discovering that certain items, previously ordered routinely, are no longer necessary, resulting in cost savings.

3. Rolling (or Continuous) Budgets:

  • Scenario: FreshBite Foods wants a more adaptive approach to its research and development (R&D) budget given the constantly changing nature of consumer preferences in the organic foods market.
  • Process: Initially, FreshBite sets a 12-month R&D budget. As January concludes, they add another budget for the upcoming January, adjusting for new insights, market conditions, and outcomes from the past year’s R&D projects. This approach ensures they always have a clear, forward-looking budget for the next 12 months.

Each of these examples emphasizes how different budgeting models are designed to handle different challenges and goals. While Incremental Budgeting is straightforward and less time-consuming, it might overlook inefficiencies. Zero-Based Budgeting, while more time-intensive, can highlight and eliminate wasteful spending. The Rolling Budget allows a company to continuously adapt to changing conditions, ensuring that they’re always prepared for the future.

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