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When deciding what numbers to put in their budget, many people aren’t sure where to start. Should you just do the same budget as last year or start afresh? Are your activities the same as before, or are you doing things quite differently? Ultimately you should try to consider your organization’s or team’s strategy and how it will impact on your team’s objectives. Objectives, however, are only aims and not guarantees of what will take place. The only hard facts you have are past activities and performance. What options are open to you in linking your budget to strategy while making use of historic data?
Incremental Budgeting
An incremental budget is drawn up by making incremental changes to the former budgeted or actual figures.
Incremental Budgeting is a ‘Business as Usual’ Approach
This gives a new budget with items that are a certain percentage greater (or less) than the previous budget. These adjustments will be for things such as pay rises, inflation or changes in business activity.
The premise is that things won’t have changed much from last year. If you want to use this type of budget, you should make sure that your strategy and objectives have not altered from the previous budgetary period.
The advantage of incremental budgeting is that it is relatively quick and simple to look at the historic data and make small adjustments in order to allocate resources. However, you must be careful that the historic data that you are using is accurate and that it reflects efficient performance.
Zero Base Budgeting (ZBB)
A zero base budget is where all the activities are re-evaluated each time the budget is set.
Zero Base Budgeting is a ‘Start Afresh’ Approach
The premise is that with each new budgetary period, the budget items all start with no money allocated to them. Furthermore, each of these items is revisited to check that no budget items are missing from the list or need to be removed. The budget items then have funds allocated to them in line with the needs determined by the current strategy. In doing this, objectives and activities are prioritized, and alternative ways of conducting each activity are explored.
ZBB means that budget items are justified on a systematic basis and in the context of future plans, as opposed to past performance. The ZBB approach is a good one to adopt if you have a lot of time to prepare your budget and things have changed dramatically from the previous period.
A Hybrid Approach
As there are advantages and disadvantages of each of the above approaches, it is possible to adopt a cross between the two so as to get the benefits of both. Examples of this are:
- Creating a ZBB budget in the medium term (e.g. every five years) with incremental budgets in the intervening period.
- Adopting a ZBB review for functional areas that undergo significant changes in their activities (e.g. ZBB for a production team investing in a new technology and incremental budgets for the other teams that are largely unchanged).
- A sample of teams/departments is subject to ZBB during each budgetary period while the rest continue with incremental budgets.
