There are several approaches to budgeting, each with its own advantages and suitability depending on a company's goals, tasks, and characteristics.
Main Approaches to Budgeting
Incremental Budgeting
This method is based on the budget from the previous period, with certain amounts added or subtracted depending on changes in the business.
- Advantages: Simplicity and speed of preparation, reduced risk of errors.
- Disadvantages: Does not encourage efficiency, may overlook significant changes in the business environment.
Zero-Based Budgeting
In this approach, every expense item must be justified from scratch, without considering previous periods' data.
- Advantages: Increased accuracy, encourages reassessment of priorities and expense optimization.
- Disadvantages: Time-consuming, requires significant effort to justify each item.
Program-Target Budgeting
Expenses are grouped and planned according to specific programs or projects, each with its own goals.
- Advantages: Ease of controlling the targeted use of funds, increases accountability for achieving goals.
- Disadvantages: May be difficult to implement in companies with large and diverse activities.
Activity-Based Budgeting (ABB)
Budgeting is based on the analysis of business processes and activities necessary to achieve the company's goals.
- Advantages: High accuracy, provides better insight into which actions create added value.
- Disadvantages: High implementation costs, requires in-depth process analysis.
Rolling Budgeting
The budget is continuously reviewed and updated based on current data, usually quarterly or monthly.
- Advantages: Budget relevance, ability to respond flexibly to changes in the external environment.
- Disadvantages: Time-consuming, requires constant monitoring and analysis.
Flexible Budgeting
Involves creating several budget options depending on different scenarios (e.g., optimistic, pessimistic, realistic).
- Advantages: Allows preparation for various scenarios, reduces the risk of surprises.
- Disadvantages: Increases budgeting complexity, requires additional resources for analysis.
Top-Down and Bottom-Up Budgeting
- Top-Down: Management sets the main financial goals and limits, which departments then use to form their budgets.
- Bottom-Up: Departments independently form their budgets, which are then coordinated and combined into the overall company budget.
- Advantages:
- Top-Down: Clear direction from management, simplified control.
- Bottom-Up: More realistic forecasts, employee involvement.
- Disadvantages:
- Top-Down: Potential detachment from reality, lack of motivation at the grassroots level.
- Bottom-Up: Difficulty in coordinating and integrating budgets.
Each of these approaches can be used depending on the company's specifics, strategy, and external environment. In some cases, it may be beneficial to combine several methods to achieve the best results.
Choosing a Budgeting Approach
The choice of a budgeting approach depends on various factors related to the organization's characteristics, strategy, management culture, as well as the external and internal environment.
Analysis of Company Goals and Strategy
First, it is necessary to define the company's long-term goals and strategies for achieving them. If the company is focused on rapid growth or transformation, flexible approaches such as rolling budgeting may be useful. For stable companies with predictable processes, an incremental approach may be suitable.
Assessment of the Current State of the Business
Next, analyze the current financial position, expense structure, and process efficiency. Companies with a high level of stability and predictability may opt for incremental budgeting, while those looking to optimize costs might prefer zero-based budgeting or activity-based budgeting.
Understanding Business Processes and Their Complexity
Then, assess the complexity and variability of the business processes within the company. If business processes are complex and require precise understanding of costs, the Activity-Based Budgeting (ABB) approach may be most appropriate.
Resources and Competencies
Next, evaluate the availability of resources, time, and competencies for developing and maintaining the chosen budgeting method. If the company has limited resources or experience, simple methods such as incremental budgeting may be preferred. More complex methods like zero-based budgeting require significant resources and competencies.
Level of Uncertainty and External Environmental Changes
It is also important to consider the influence of external factors such as market uncertainty, economic conditions, and legislative changes. In highly uncertain conditions, approaches that involve regular budget reviews (e.g., rolling budgeting) provide greater flexibility and adaptability.
Organizational Culture and Management Style
Then, assess the company's readiness for changes, employee involvement, and management centralization. In companies with decentralized management and high employee involvement, bottom-up approaches may work more effectively. In companies with a strict hierarchy and centralized management, a top-down approach may be more appropriate.
Timeframes
It's also important to define the timeframes within which the budget needs to be prepared. If a budget needs to be prepared quickly, simpler and faster approaches like incremental budgeting are preferable.
Requirements of External and Internal Stakeholders
Consider the requirements of shareholders, investors, creditors, as well as internal reporting needs. Some stakeholders may require more detailed or forecast information, which may necessitate using more complex budgeting methods.
Pilot Testing and Evaluation
Finally, conduct a pilot test of the selected approach on a small part of the business. Testing allows for assessing how well the chosen approach meets the company's needs and making adjustments before full implementation.
Budgeting Software
Implementing the selected budgeting approach in software requires careful planning and system configuration according to the methodology used by the company.
Selecting the Right Software
Determine which budgeting software best suits the company's needs and chosen approach. Consider the software's functional capabilities, such as support for various budgeting methods, integration with other systems, ease of use, scalability, and cost.
Configuring Software Parameters to Match the Selected Approach
Set up the main parameters of the software according to the chosen budgeting approach.
For example:
- For incremental budgeting, set up templates based on past budget periods, with the ability to automatically recalculate considering changes (e.g., inflation).
- For zero-based budgeting, configure the system so that each expense item starts from zero and requires justification.
- For Activity-Based Budgeting (ABB), identify key business processes and activities, create corresponding cost centers, and set up cost calculation by activity.
- For rolling budgeting, set up automatic budget data updates on a specified cycle (quarterly or monthly).
Developing Budget Templates and Forms
Create templates for budget forms and reports according to the chosen approach. Define what data should be entered, how it will be aggregated, and how final budgets and reports will be generated.
For example:
- In incremental budgeting, create templates with baseline values from previous years.
- In zero-based budgeting, create blank forms that need to be filled from scratch.
- In ABB, develop forms for collecting data on specific activities.
Integration with Other Systems
Ensure that the budgeting software is integrated with other company systems such as ERP, CRM, HRM, and accounting systems. Set up data exchange between systems so that information on revenues, expenses, and other key indicators is automatically pulled into the budgeting software.
Setting Up Approval and Authorization Processes
Set up processes for budget approval and authorization in line with corporate policy. Define access rights for different management levels and establish procedures for reviewing and approving budget data.
For example:
- For the bottom-up approach, set up a sequential budget approval process from departments to senior management.
- For the top-down approach, configure automatic distribution of key indicators and limits to departments after management approval.
