Creating a budget is an effective way to help you avoid overspending. To get started, it’s useful to first understand the different types of budgets, their benefits, and the key principles to keep in mind when preparing one. You can learn all of this in this article—so let’s dive in!
What Is a Budget?
According to Investopedia, a budget is an estimate of income and expenses prepared for a specific period in the future.
This can be done by individuals, households, governments, or businesses of any income level. Its purpose is to estimate how much money will be spent based on the income received.
A budget can help you avoid overspending while ensuring that necessary expenses are covered. Budgets are typically prepared for specific periods and are evaluated regularly.
You can also create a budget using pen and paper, a spreadsheet, or a versatile business app like Labamu.
Types of Budgets
In this article, Labamu will specifically focus on the types of budgets commonly used by businesses. According to Bedford Consulting, the following are some of the most frequently used types. Each comes with its own advantages and drawbacks, which will be discussed in more detail below.
1. Traditional Budget
Also known as an incremental budget, this type of budget is prepared based on the previous period’s budget—usually with only minor adjustments to set the new budget.
Advantages:
- It is the most commonly used, straightforward, and proven to be effective.
- It is relatively easy to create since it is based on budgets from previous years.
Disadvantages:
- It has the potential to perpetuate inefficiencies from the previous budget.
- It carries the risk of being unresponsive to changes in the market or business environment.
It is suitable for stable business environments and companies that prefer tried-and-tested methods.
2. Zero-Based Budget
In contrast to incremental budgeting, a zero-based budget is created from scratch for each new period, without considering the previous period’s budget.
Advantages:
- It encourages a review of spending inefficiencies, resulting in a more effective budget.
- It aligns spending with the current situation and conditions.
Disadvantages:
- It requires more time and resources to prepare.
- It can be challenging to implement, especially in large-scale businesses.
It is suitable for businesses seeking a comprehensive financial review or undergoing a restructuring phase.
3. Activity-Based Budget
An activity-based budget is prepared based on the activities required to produce a product or service, and is adjusted according to operational outputs.
Advantages:
- It allocates resources more strategically and according to their priorities.
- It provides a detailed view of how resources are allocated and used.
Disadvantages:
- It can be complex and time-consuming, which may hinder or delay its implementation.
- It requires detailed analysis and a thorough understanding of processes and activities.
It is suitable for companies that want to align their financial planning with operational activities or expected outcomes.
4. Value Proposition Budgeting
A value proposition budget is a budget in which spending priorities are determined based on their expected return on investment (ROI).
Advantages:
- It focuses on activities that add value to the business.
- It prioritizes spending based on the return on investment of activities.
Disadvantages:
- It can be quite challenging because determining value can be highly subjective.
- It has the potential to overlook important functions that do not generate a direct or tangible ROI.
It is suitable for businesses that want to align their budget with strategic goals and value creation.
5. Rolling Budget
Also known as a continuous budget or rolling budget, this type of budget is dynamic and updated regularly, monthly or quarterly throughout the budget period.
Advantages:
- It provides greater flexibility and strategic alignment.
- It allows businesses to adapt quickly to changing conditions.
Disadvantages:
- It requires regular updates, which can be resource-intensive.
- It tends to focus primarily on short-term planning.
It is suitable for fast-changing business environments where an annual budget may be inefficient.
6. Project-Based Budget
As the name suggests, a project-based budget is prepared for a specific project, providing a more realistic and accurate estimate.
Advantages:
- It ensures financial alignment with the ongoing project.
- It allocates resources to each project more effectively.
Disadvantages:
- It is not a holistic approach for the entire organization.
- It requires continuous updates to accommodate changes in project requirements.
It is suitable for businesses managing multiple projects simultaneously.
7. Participatory Budget
A participatory budget, also known as a bottom-up budget, is a type of budget prepared by individual departments or teams, with each team contributing to the budget development process.
Advantages:
- It involves multiple departments, resulting in more realistic and diverse insights.
- It enhances commitment to the budget.
Disadvantages:
- It can be a lengthy and time-consuming process.
- There is a risk of inflated budget requests.
It is suitable for businesses that want to boost internal engagement in the budgeting process and leverage insights from their employees.
8. Flexible Budget
The final type is the flexible budget, which is prepared based on the actual level of activity during a given period.
Advantages:
- It can be adjusted to actual operational activity and provides real-time financial clarity.
- It allows for a direct comparison between actual performance and the budgeted figures.
Disadvantages:
- It requires a more sophisticated financial system.
- It is more complex to prepare initially.
It is suitable for businesses with varying operational levels or fluctuating demand, such as seasonal businesses.
Principles of Budgeting
From the types of budgets mentioned, along with their drawbacks, advantages, and suitability, there are key principles you should understand when preparing a budget:
- Use budgeting methods that are appropriate for the business’s structure, conditions, and activities.
- Prepare it at the beginning of the financial period so it can be used as a control tool and to assess its effectiveness and efficiency throughout the period.
- A budget should be collaborative and include input and feedback from all stakeholders, including employees, executives, departments, and management.
- A budget should be comprehensive, covering all aspects of financial activity, and based on realistic estimates of income and expenses.
- Management should be transparent and open about the budget with all departments to enhance communication and coordination.
- Financial and monetary objectives should be clear and well-defined before planning the budget.
- A budget must be able to adapt to changes in the business environment, so the company should regularly monitor and adjust it as needed.
Those are the types of budgets and the principles you should keep in mind when preparing them. As for transaction records and administration, leave it all to Labamu.
With just one app, you can enjoy a variety of free and paid features to support your business operations. Join over 84,000 other entrepreneurs who are already using this app to manage their businesses. Download it now on Google Play or the App Store, Labamu friends!
