Budgeting Method: Explained

What is it, how to calculate it, formula, why it's important

Yo yo my peeps! I’ve been playing the CFO game for quite a while now, and let me tell you - it’s all about budgeting! Budgeting is like the foundation of a house, without it, everything would crumble down. And trust me, nobody wants a financial apocalypse.

What’s a Budgeting Method?

Budgeting methods are an essential tool that every company, big or small, should be using. They make it much easier to manage company finances, avoid overspending, and aid executives in making better financial decisions. A budgeting method basically outlines a standardized way to handle expenses, revenue, and cash flow..

Zero-Based Budgeting

Zero-based budgeting is one of my favorites and it’s a great method for companies who are trying to start from scratch. This budgeting tactic is straightforward - it requires the budgeting team to justify every expense from scratch, starting from zero, without the baggage of previous expenses and purchases. This technique results in a much more streamlined, efficient budgeting process, and it helps businesses identify areas where unnecessary expenses can be completely eliminated.

This method may be more time-consuming than others, but the amount of time and resources saved in the long run more than makes up for the initial investment.

Activity-Based Budgeting

Activity-Based Budgeting, also known as ABC, is another near and dear method to me. In this method, budgeting is approached from the standpoint of the relationship between activities and costs. ABC identifies activities that drive costs as the foundation for building the budget. Managers first separate expenses by activity, then budget for those activities, and ultimately analyze and optimize how the relationship between these activities has a correlation with the company’s overhead costs.

Because ABC is activity-driven, it’s an especially useful tool for companies with large-scale production or service delivery models.

Incremental Budgeting

Incremental budgeting is one of the most common budgeting methods, but also considered one of the easiest. Incremental budgeting is a year-to-year approach to budgeting since it largely depends on previous years’ expenses and revenue. The focus is on predicting future revenue and funding needs, while assuming that past spending levels can be maintained. With incremental budgeting, the budget is generated by adjusting the previous year’s budget up or down accordingly.

Although mostly easy to use, incremental budgeting can lead to over-spending when prior budgets are set too generously. Therefore, it’s important to ensure that adjustments are made or that the budget is reviewed frequently to avoid falling into this budgeting pitfall.

Bottom-Up Budgeting

Bottom-up budgeting is what it sounds like. The budget is generated by individual departments and then integrated into the overall budget for the company. The departments are allowed to predict their own revenue and expenditures, so it takes an all-encompassing, well-oiled machine, and adds the parts together. This method is also called “participative” budgeting because everyone involved is eligible and given input in the creation of the budget.

Bottom-up budgeting can be a time-consuming method because of the collaborative effort it requires, but the benefits usually end up being greater than the cost. Because everyone is given a stake in the budget, buy-in from the team will be stronger, and the transparency this approach creates is deeply valuable to any company.

The Final Word

There you have it, amigos, the best budgeting methods out there. Each budgeting method offers unique advantages to businesses, so it’s essential to consider which best fits your needs before taking the leap. I hope my experience in the financial world can help you find your financial footing. Happy budgeting!

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