A one-size-fits-all solution is rare in business, and that’s certainly the case for budgeting. Building a budget for your business requires strategy and finesse. Between size, age, industry, location, and goals, you will need to weigh many factors for a budget that meets your needs.
There are six main budgeting techniques that help you determine what your budget should be for the growth and health of your business:
- Incremental Budgeting
- Activity-based budgeting
- Value proposition budgeting
- Zero-based budgeting
- Cash flow budgeting
- Surplus budgeting
We’re going through each type of budgeting in detail to help you consider your budgeting option.
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6 types of business budgeting
Your company budget should be a living strategy that informs business decisions. A critical part of budgeting is the ability to control employee spend so that you never go over budget. Each of these six methods establishes a framework that is best supported by real-time budgeting software.
Most budgeting methods begin with an operating budget, meaning you first create a high level overview of how much money is coming in and how much is going out. Generally your operating budget is just a summary of revenue, fixed costs, and variable costs you can expect for the upcoming quarter or year. You may also choose to create a master budget, which is an operational budget that reflects the budget for the entire company without the breakdowns within each departmental budget. Then you can move into a more involved process for determining budget guidelines.
Static vs. Flexible: each budget style is either static or flexible. Static budgets are set and do not change. Flexible budgets are more fluid, and can be adjusted at any time.
Incremental budgeting is the easiest, but most-abused, form of business budgeting, and is probably what you imagine when you think of a traditional budget. With incremental budgeting, you simply adjust the existing budget by increments to reflect the overall growth or decline of the company. For example, projecting 10% growth might mean you increase budgets by 10%, or if it’s time for your business to cut back you may call for a 30% budget reduction across the board.
Incremental budgeting is very quick to calculate, and can facilitate company-wide budget adjustments. However, there are many issues with incremental budgeting. You may be increasing an unnecessary budget, or you may have budget owners requesting a larger increase so that they can show how they come under budget. It’s also harder to factor in more complex data like inflation or market trends into your operational budget.
The activity-based budgeting method is focused on the results you wish to achieve. For example, if your company is seeking a certain valuation or to do $100M in sales, you would work backward to determine which activities will create that desired effect, and then fund them accordingly.
Activity-based budgeting can be highly effective when you have a clear end zone and focus on a goal-oriented operation. However, it is important to carefully weigh all company efforts, even those that don’t contribute directly, to a financial goal but keep your operation running smoothly. Activity-based budgeting methods work especially well in the short-term to meet a specific financial goal, but can be limited when used for long-term application.
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Value proposition budgeting
Value proposition budgeting is all about, well, value. Each and every budget line item is analyzed to determine the value it provides to the business, customer, staff, and stakeholders—as well as the cost. Budgets need to be itemized and justified to prove value for the business, eliminating cost that ultimately does not bring value and maximizing the budget in areas that deliver strong results.
Value proposition budgeting can be used in conjunction with other methods, such as activity-based budgeting, on a small or large scale. You may require that your largest budgets within the company conduct value proposition budgeting to justify their spending plan, or you may conduct value proposition budgeting company-wide. Remember that value is sometimes difficult to quantify, and the value offered by different departments or initiatives can change rapidly.
Zero-based budgeting is a flexible budgeting method that requires line-by-line justification of budgets and purchasing. However, zero-based budgeting is used to economize and trim budgets of excess spending. Whereas incremental budgeting just increases or decreases lump sums across the board, zero-based budgeting begins with the assumption that each and every department is starting off at zero. Each department needs to plan and price out and justify each penny, building their budget from the ground up.
Zero-based budgeting is the best method for eliminating extra spending, but is a much more exhaustive process. Complete control and visibility into budgets allows for conscious spending and saving. Zero-based budgeting can be the most effective for finding ways to meet savings goals, which are important for the safety of a small business.
Flexible budgeting methods
What happens when your budget is off target? The market can be unpredictable, and as a business owner you need to be prepared for the moment when your budget is out of balance. There are some budgeting strategies you can employ to help you through moments when the numbers don’t add up.
Cash flow budgeting
When you run out of money due to lack of revenue to your business or increased spend, what can you do? There are ways to increase the cash flow to your business, but hopefully your budgeting method accounts for a safety net, such as a strong savings account or potential lines of credit.
The best budgeting surprise is when you discover a surplus. What is your plan when you bring in more revenue than expected, or when your teams come in under budget? Will you reward teams for returning surplus funds? How will you utilize the extra cash? Savings or debt repayment are smart choices, but you may also create a plan for reinvesting the money back into the business with purchase of equipment or beneficial training.
Regardless of which budgeting method you choose, without expense management you won’t achieve anything. Assigning, documenting, tracking, and analyzing your business expenses is key for true and effective budgeting. It’s time to assess your expense management needs with Divvy.
Within the budgeting methods there are also ways to implement the budgeting within your company. You can adjust each budgeting method for the needs of your company by adjusting the involvement of your employees in the budgeting process. Of course, an enormous international corporation is unable to involve local managers in the budgeting process, but small businesses may find that a collaborative effort with managers and employees creates more buy-in and effective execution.
The most traditional method of budget involvement is an imposed budget. Imposed budgets are created and executed from the top down. The corporate or finance teams make decisions about budgets for departments and overall spending, then communicate the budgets unilaterally. Imposed budgets are often called top-down budgets. While often necessary, imposed budgets can leave employees feeling unheard by out-of-touch executives.
A more flexible and functional form of budget involvement is negotiated budgeting. In negotiated budgeting, suggestions come from the top-down and the bottom-up and are met in the middle with communication and negotiation. For example, you may be utilizing value proposition budgeting and want to involve more managers and employees in the process. You might have executives meet with managers, both coming prepared with their projections of value within departments to construct the budgets together.
Empower your employees with collaborative budgets and corporate cards for everyone.
When your business requires a lot of decision-making on the front lines, smart business owners learn to trust in participative budgeting. As the most bottom-up approach, participative budgeting works well for small businesses with high levels of trust and communication. Managers and employees can recommend budget targets and be given freedom within their budgets. Incremental budgeting can be highly participative if increases or reductions are made and then the budgets are handed off to managers to be used at their discretion.
Are you ready to build your business budget? We hope this empowers you to create budgets that work for your business and your future goals. A budget is your roadmap to success, so draw it up with care. And remember—your budget is nothing but a wish list if you aren’t able to carefully track business expenses and conduct meticulous expense management.