When you budget correctly, you reap a lot of the benefits of budgeting. Budgeting methods can help you identify gaps in your spending, control them, and potentially increase your savings rate. But nothing great comes easy, and the budgeting process will not necessarily increase your bank balance. Indeed, there are pros and cons of budgeting, depending on your budgeting style, anticipated level of budgetary control, and business objectives.
Without a doubt, a strategic plan of cost containment will take you a long way in achieving your financial goals, but the disadvantages of budgeting should also be kept in mind — these can be a major headache.
What are the advantages of budgeting? What are the drawbacks? This article aims to identify the benefits of budgeting while also addressing the factors to blame for outcomes unfavorable for your company goals while you try to get your expenses under control.
Common Budgeting Techniques and Strategies
1. Incremental Budgeting
In incremental budgeting, one takes into account the actual figures from the preceding year. These figures are multiplied by a certain percentage (above or below 100%) to obtain the budget for the current year.
Incremental budgeting is a beneficial method especially if the primary cost drivers remain constant throughout business cycles over the years. It is also an easy-to-understand method that is convenient to use.
Where can incremental budgeting go wrong? The few factors below are where this type of budgeting lacks:
- There are chances incremental budgeting leads to budgetary slack. Business managers may overvalue the budget needed to give the impression that the team is always under budget.
- It will not reduce inefficiencies in the business. Managers can exploit this method by increasing budgets every year without seeking ways of efficient cost containment.
- It does not consider external factors of activity and performance.
2. Zero-Based Budgeting (ZBB)
Another commonly used method of budgeting, zero-based budgeting (ZBB), bases budgeting on an empty foundation and starts from scratch. One assumes that all the department budgets are zero and adds any expenses they deem necessary. In this type of budgeting, every expenditure must be justified by managers before it’s added to the overall budget.
ZBB, as the budgeting process implies, is a tight budgeting method that can be very effective financially if you are aiming to only include the vital expenditures in your budget. This budgeting style comes in handy when a business plans to restructure its processes financially or is facing a market recession that requires it to reduce its budget dramatically.
3. Rolling (Continuous) Budgeting
Continuous budgeting is a rigorous budgeting process which keeps every budget period short. One has to add a new budget every month or every quarter while considering any changes, threats, and opportunities. This method allows you to stay one step ahead but certainly comes with its challenges.
Constantly restructuring your budget through a rolling forecast refines your financial plan with an eye on long-term goals. It reduces risks by considering different threats and scenarios and keeps your planning and budgeting aligned with your organizational goals.
4. Activity-Based Budgeting (ABB)
Activity-based budgeting (ABB), also called value proposition budgeting, is a commonly used top-down budgeting method that bases budgeting on company activities’ facilitation. First, one has to pinpoint and list the activities that are likely to drive cost. Then they allocate resources to ensure the achievement of objectives of the anticipated levels of activities.
This method enhances efficiency by linking every function of an organization with its spending. This ensures that departments are rarely operating over or under budget. Cost containment using this method of budgeting also eliminates redundancy; any activities or functions that are not adding value undergo corrective action in the form of restructuring or removal.
The disadvantages of ABB are that firstly, it does not focus on long-term goals and strategies. Therefore, it can be shortsighted. Another disadvantage of budget control through ABB is that it requires determination of the workforce and scarcity of resources.
5. Performance-Based Budgeting (PBB)
Another result-oriented approach to budgeting is performance-based budgeting (PBB). This associated funds and budgets with specific objectives. These objectives or desired outcomes form the foundation of activities a company performs, with costs being a driving force behind them.
This goal-oriented approach pinpoints and assigns the essential objectives to all entities and provides enough resources to help departments achieve their respective goals.
Advantages and Disadvantages of Budgeting
Benefits of Budgeting
- The first advantage of budgeting is that it ensures efficiency and increases the chances that your company will achieve its goals and objectives,
- Helps find flaws in the financial structuring,
- Helps business owners find prevention strategies for their cost management,
- More effective resource allocation and distribution of activities across departments,
- Another advantage of budgeting is that coordination increases with goal-oriented approaches,
- Linking activities with outcomes and objectives encourages employees,
- Some budgeting methods help with long-term goals.
Drawbacks of Budgeting
- Setting realistic goals and targets is important since otherwise employees will be intimidated and demotivated,
- Similarly, strict regulations on resources will put all the pressure on the workforce and might get too stressful for employees,
- Operational planning and financing may go to waste if there is no coordination between departments and functions,
- One of the major problems about setting targets is that staff will generally aim to achieve it, not exceed it,
- There is no flexibility for out-of-the-box solutions; everything is planned and coordinated,
- If focus is kept primarily on one business metric, other essential metrics detriment,
This article explored the common budgeting techniques and strategies and gave insight as to their pros and cons. The article also aimed to evaluate the general advantages and disadvantages of budgeting. We hope that reading about the benefits of budgeting encourages you to implement certain budgeting techniques in your organization.
What is your preferred budgeting method? What benefits and drawbacks do you think are associated with it? Maybe personalized assessment, along with the information provided in this post, will help you on your cost containment journey. Happy budgeting!