Businesses commonly use four types of budgeting approaches: incremental budgeting, activity-based budgeting, value proposition budgeting, and zero-based budgeting. Each method comes with unique benefits and drawbacks depending on the organization’s goals and context.
1. Incremental Budgeting
This traditional approach builds the new budget by adjusting the previous year’s actual figures—typically by increasing or decreasing them by a set percentage. It’s popular due to its simplicity and familiarity.
- Best for: Stable environments where operations and costs remain consistent year to year.
- Drawbacks: May encourage inefficiencies, budget padding, and fails to consider changes in market conditions or organizational strategy.
2. Activity-Based Budgeting (ABB)
This method starts with revenue goals and works backward, identifying the specific activities and associated resources needed to meet those targets. It’s more analytical and top-down in nature.
- Best for: Companies focused on aligning expenditures with strategic objectives or output goals.
- Drawbacks: Can be complex and time-consuming to implement.
3. Value Proposition Budgeting
This approach asks whether each budget item provides meaningful value to stakeholders—whether internal (employees) or external (customers).
- Key Questions:
- Why is this expense necessary?
- Does it offer value that justifies the cost?
- Best for: Organizations aiming to eliminate waste and ensure every dollar spent supports core values or objectives.
4. Zero-Based Budgeting (ZBB)
Zero-based budgeting requires all expenses to be justified from scratch—nothing is carried over from previous budgets automatically. It’s rigorous and forces critical review of all spending.
- Best for: Times of financial constraint or organizational restructuring.
- Drawbacks: Resource-intensive and often used selectively due to the time commitment.
Levels of Budgeting Involvement
The budgeting process can vary in terms of who participates and how much influence they have. There’s often a trade-off between achieving alignment across the organization and maintaining efficiency in decision-making.
Imposed Budgeting
- A top-down process where senior leadership sets goals and dictates budget targets to managers.
- Best used: In high-pressure or turnaround situations where quick decisions are needed.
- Limitation: May reduce buy-in from staff who aren’t involved in planning.
Negotiated Budgeting
- A hybrid approach combining top-down goals with bottom-up input from department heads and team leaders.
- Advantage: Encourages collaboration and greater ownership of budget targets.
Participative Budgeting
- A bottom-up method where employees and managers propose budget figures and targets, which are then reviewed by executives.
- Best for: Decentralized organizations where operational units act with significant autonomy.
- Benefit: High levels of employee engagement and accountability.