Budget methodologies
Several methodologies are available for defining budgets in your organization. Two of these methods are:
Zero-based budgeting
Historical budgeting
Zero-based budgeting
Zero-based budgeting is a method of planning and decision making that reverses the working process of traditional budgeting. In traditional incremental budgeting, departmental managers justify only increases over the previous year's budget, and the system automatically sanctions what's already been spent.
In zero-based budgeting, the organization comprehensively reviews every department function, and they must approve all expenditures rather than only increases. This type of budgeting makes no reference to the previous level of expenditure. Zero-based budgeting requires that each division manager justifies the budget request in complete detail, starting from the zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing.
Some advantages of using zero-based budgeting include:
Allocating resources efficiently because it's based on needs and benefits.
Driving managers to find cost-effective ways to improve operations.
Helping detect inflated budgets.
Identifying and helping you eliminate wasteful and obsolete operations.
Identifying opportunities for outsourcing.
Forcing cost centers to identify their mission and their relationship to overall goals.
Helping identify areas of wasteful expenditure and, if desired, for suggesting alternative courses of action.
Historical budgeting
Historical budgeting, sometimes referred to as incremental budgeting, uses a budget that you prepare by using a previous period's budget or actual performance as a base, with incremental amounts added for the new budget period.
The allocation of resources is based on allocations from the previous period. We don't recommend this approach because it fails to consider changing circumstances. Moreover, it encourages "spending up to the budget" to ensure a reasonable allocation in the next period. It leads to a "spend it or lose it" mentality.
Advantages of historical budgeting include:
The budget is stable and change is gradual.
Managers can operate their departments on a consistent basis.
The system is relatively simple to operate and understand.
Conflict avoidance can occur when departments appear to be treated similarly.
Coordination between budgets is more efficient to achieve.
Potential for experiencing a quick impact of change.