6 types of budgeting methods for business success

There are many types of budgeting methods entrepreneurs can follow, but none of them are one-size-fits-all options. The budgeting method that’s best for your business is one that matches your situation, your project plan, and your overall goals.

These budgeting methods can show you how to manage your finances to fund that next project and help your business grow.

1. Activity-based budgeting

Unlike some budgeting methods for business that rank the importance of expenditures and weight of future plans accordingly, activity-based budgeting (ABB) takes all of a business’s cost-related activities into consideration. To use this system, you’ll need to track and analyze every single action your business takes that could cost money. Then, you’ll examine those items to see where you can be more efficient.”

For example, say you have a burger restaurant, and you know it takes $5 to make each burger combo. You sell about 30,000 burger combos each year. Those 30,000 combos x $5 each = $150,000. That’s your base budget for burgers. You’d then repeat the same calculation for every activity or menu item.

This budgeting approach is best for businesses that need an extremely accurate representation of costs and how expenses are allocated — but fair warning, ABB can be time-consuming to complete.

2. Incremental budgeting

Incremental budgeting builds on existing budgets from previous quarters or fiscal years, reducing the amount of work you must do up front. You just take your expense list from a pre-determined period, then adjust based on projections for higher costs in the coming year, predicted revenue growth, etc. You’d also adjust the new budget based on how under or over budget you were previously.

Incremental budgeting is a popular choice for smaller businesses because it doesn’t require accounting expertise. You can run the numbers quickly and likely without outside help, but you may not have as much accuracy as you would using another method, such as ABB, which goes into more detail. You also risk overspending if you’re basing your new budget on numbers that already reflect unnecessary costs.

3. Value proposition budgeting

In many ways, value proposition budgeting (VPB) is the most comprehensive type of budgeting in business. That’s because VPB encourages you to look at not just the numbers, but what the numbers mean and represent. You might use the following questions to understand their relevancy:

• How much are we spending on A?
• Why is A important to our business?
• What value is A offering? This question applies not only to customers, but to staff and other interested parties, such as investors.
• Does the value of A justify its cost?

The answers to these questions can help you determine not only how much money to spend, but whether you should be spending it at all.

4. Zero-based budgeting

Feel like you need a clean slate? Or perhaps you’re building a business from scratch? If you want to start fresh, you might benefit most from zero-based budgeting (ZBB). This approach works under the guise that every new fiscal year or at the start of each quarter, the budget starts at zero. Nothing from the previous year is automatically carried over.

Instead, managers from each department essentially pitch their expenses, making their case for all costs and why those expenses are essential to the company’s success. This process can take time, and you may need an expert or even a committee to help make the right decisions on each pitch. However, the result will be a detailed budget that should limit frivolous expenditures and give you more money to allocate as needed.

5. Flexible budgeting

Flexible budgets are adaptable, changing to match your revenue. This can be a strong approach for businesses that don’t expect the same revenue day in and day out. For example, you may have a restaurant that does strong during the summer due to the tourist season but gets very slow in the winter. You wouldn’t want to allocate the same amount of expenses for both seasons, because you’ll likely have to pay out more in summer to get the appropriate inventory, staffing, etc.

Flexible budgets can be best for businesses with big swings in revenue, but know that this method requires careful tracking to help avoid running a budget that’s too tight or too lenient.

6. Envelope budgeting

If you’re not great with numbers or just don’t have a dedicated bookkeeping and accounting staff, you may appreciate envelope budgeting. As the name suggests, this method has you putting a specific amount of money into physical or digital envelopes labeled with a certain category. When that cash is gone, you’ve used up the budget for that department or type of expense for that month or budgeting period.

Typically, the amount budgeted for each category is based on a combination of historical spending and guesswork. You may not have to do much work, but you could also end up under- or overestimating your budget and find yourself running out of money at inopportune times.

Envelope budgeting can be best left to very small businesses where you’re dealing with triple-digit budgets rather than tens of thousands of dollars. The best budgeting strategies for businesses may change over time. You may run incremental budgeting for quarterly budgets, and then every other year try zero-based budgeting to shake things up and re-examine your finances in totality.

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This information is intended solely for informational purposes and should not be interpreted as legal, financial, or tax advice. Readers are strongly advised to consult with their attorneys, financial advisors, or tax professionals to obtain guidance tailored to their specific circumstances.