Budgeting is a crucial aspect of financial management for both individuals and businesses. It helps in planning and allocating resources effectively to achieve financial goals. However, there isn’t a one-size-fits-all approach to budgeting.

Different situations and objectives call for different types of budgets. In this post, we will explore various types of budgets, their advantages, and when to use them.

1. The 50/30/20 Budget

If you’re looking for a simple and straightforward budgeting method, the 50/30/20 budget might be the right fit for you. This popular budgeting approach allocates percentages of your net income to different spending categories: essentials, savings, and discretionary expenses.

The essential expenses (50%) include necessities like food, housing, utilities, transportation, and basic clothing. These are the must-haves that you need to cover to maintain your daily life.

The savings (20%) category encompasses your savings and debt repayment. It’s important to set aside a portion of your income for future financial security or to pay off any outstanding debts.

The remaining discretionary expenses (30%) are for your enjoyment, such as vacations, entertainment, dining out, and gifts. It allows you to have some fun and indulge in non-essential items without compromising your financial stability.

This budgeting method is great for those who prefer simplicity and don’t want to get caught up in the details. For example, if you have a monthly net income of #30,000, you would allocate #15,000 for essentials, #6,000 for savings, and #9,000 for discretionary expenses.

However, it’s important to note that the 50/30/20 budget may not be suitable for everyone. In certain situations, it can be challenging to stick to the percentage breakdown. If you have a low income near the poverty threshold or live in a city with high housing costs, it might be difficult to stay within the 50% allocated for essential expenses. In such cases, you may need to adjust the percentages according to your specific circumstances.

2. Incremental Budgeting

Incremental budgeting, also known as standard budgeting, is a traditional approach where the current year’s budget and actual numbers serve as the starting point for the next year’s budget. This method takes into account the previous year’s budget figures, combines them with actual numbers from the current year, and incorporates any remaining forecasts.

The next step involves making specific adjustments to predictable items or items with noticeable and predictable changes. For example, interest expenses on an amortizing loan increase over time as the principal portion of each payment decreases. Rent payments often remain stable over several years. In some cases, financial managers may be aware of expense categories that will significantly decrease or even disappear.

Once these more predictable changes are made, it is common to apply a percentage increase to a series of accounts or departments. For instance, if the company’s leadership team plans to launch a new product, they may allow for a higher-than-normal increase in marketing expenses, which will likely require an overall budget increase for the corresponding department. Other departments, facing a status quo, may have a stable or slightly increased budget solely to account for inflation.

The primary advantage of incremental budgeting is its focus on what changes. General modifications, such as a 3.1% increase in overall personnel expenses, are relatively easy to make and do not necessarily require a significant amount of thought or in-depth discussions, making this method easier and less time-consuming.

However, the downside of this approach is that it tends to result in fewer discussions and less scrutiny. It may not necessarily prompt business leaders to closely examine the details. While incremental budgeting can be quickly achieved compared to the four other approaches mentioned in this article, it may not be as useful when implementing a highly disciplined approach to expense management.

3. Activity-Based Budgeting

Activity-based budgeting is a top-down approach that focuses on the key outcomes an organization intends to achieve. It starts with the end goal in mind and asks, “What do we need to do as an organization to reach our key objectives?” From there, activity-based budgeting defines the necessary resources and activity levels required to support those objectives.

For example, consider an organization that has developed a new innovative technology but is relatively unknown in the market. Their product requires a highly consultative sales process. If their goal is to generate #5 million in revenue in the coming year, the organization will need a direct sales force with the required technical expertise, as well as a direct lead generation process to filter potential clients.

Recommended Read: Saving And Budgeting Strategies For Nigerians Abroad

By working backward from the revenue goal of #5 million, business leaders can establish the number of transactions they need to close, the number of sales appointments they need to schedule, the size of the sales pipeline they need to generate, and so on. Each of these considerations requires a certain amount of expenses in terms of personnel, services, technology, or other resources.

Activity-based budgeting tends to focus on strategic objectives and pays less attention to expenses that cannot be directly linked to high-level goals. However, business leaders must be cautious not to push the principles of activity-based budgeting too far.

They could neglect or overlook departments that may not produce specific and measurable results aligned with the company’s strategic objectives. Nevertheless, activity-based budgeting generally provides a higher level of strategic guidance compared to other approaches on this list.

4. Value-Based Budgeting

Value-based budgeting takes a closer look at each budget item or category and asks, “Why are we spending this money?” and “What value does this money bring to our customers, employees, or other stakeholders?”

This approach strikes a balance between incremental budgeting (which, some may argue, examines too little) and zero-based budgeting (which requires managers to justify virtually every budget item, as discussed in the approach below).

Unlike activity-based budgeting, value-based budgeting seeks to justify expenses based on the value they generate, without necessarily requiring a direct link to strategic objectives.

5. Zero-Based Budgeting

Zero-based budgeting starts with a blank slate. With this approach, budget managers must establish their budget needs for the upcoming year and justify each item without considering past year figures. Just because the company spent money on a particular item in the past does not mean it must continue to do so in the future.

The zero-based approach requires budget managers to justify virtually every proposed expense. In this regard, zero-based budgeting is an excellent way to eliminate unnecessary expenses. It helps business leaders aggressively streamline bloated budgets and control costs while minimizing any negative impact on operations.

Indeed, zero-based budgeting forces companies to prioritize and adopt a more intentional approach to cost management, focusing on areas that generate the most value for the business. By requiring managers to carefully consider what they spend and the value those expenses add, zero-based budgeting often leads to new innovations, helping companies operate more efficiently.

6. Revenue-Driven Budgeting

Revenue-driven budgeting primarily focuses on key variables that have the most impact on a company’s performance. It associates the budget figures with the physical resources needed to achieve the company’s objectives for each of these variables.

These variables can include internal factors such as the total number of customers or subscribers, the number of sales representatives or distributors, or the average revenue per customer. They can also include external factors such as the overall market size, raw material prices, or even weather conditions.

Revenue-driven budgeting establishes a budget based on key business objectives, underlying assumptions about external drivers, and a results-oriented approach for internal drivers.

Conclusion

Budgeting is an essential process for managing finances effectively. Remember, budgeting is not a one-time event but an ongoing practice. Regularly reviewing and adjusting your budget allows you to stay agile and responsive to changing circumstances.