Methods of budgeting
An incremental approach
Take last year's budget, review it, and add a bit. There is nothing scientific meant by 'incremental'. Rather, 'incremental' is used in a simple and historic manner: that is, existing figures are assumed reasonable and adding an increment for price increases and possibly volume growth may be all that is needed to give reliable budget figures. However, the use of history may be the root of the problem and a more rigorous approach is needed, eg ZBB below.
Companies and individuals who are successful at budgeting are those who have a clear purpose for budgeting - clear objectives - and then follow a distinct, consistent path during the budget process.
The principal concepts within zero-based budgeting (ZBB) are not new; they are to be found in many organizations' budgeting processes. It should be noted that while many companies adopt a zero-based approach in their annual budgeting exercise, this may not be a true in-depth ZBB process, but rather a use of the general principles.
However, it is sensible to study ZBB and its underlying concepts as they illustrate how budgeting may be improved and the whole budgeting process made to deliver results.
ZBB considers: what means are available for achieving a certain result; and what (possibly) varying effort levels exist in achieving the required result. At its heart ZBB questions:
- Why is a cost incurred?
- Is incurring the cost necessary?
- What level(s) of effort are required?
- How can resources best be used?
At all times, these questions are asked with knowledge of the organization's overall, divisional, departmental, profit or cost centre objectives.
For many businesses it is also possible to consider the priorities when incurring costs and thus you may hear the term priority-based budgeting or costing.
The concept of ZBB would appear to have come from the United States in the late 1940s, but I am sure that Confucius and Archimedes discussed the concepts. ZBB appears to have been devised or at least recommended for government spending agencies, state authorities etc.