This article is for educational purposes and does not constitute legal, financial, or tax advice. For specific advice applicable to your business, please contact a professional.
Budgeting methods and tools can track where your money goes and help you make decisions for meeting financial goals. And while the typical company creates a formalized budget each fiscal period, the past few years’ events have made budgeting challenging. According to the Canadian Chamber of Commerce, in early 2022, around 50% of Canadian businesses weren’t sure if they could assume any more debt, and 80% of companies in the hospitality sector expected to pass their rising costs on to consumers.
The strains facing businesses make budgeting harder than ever, but it’s not something you can overlook or put on the back burner. Let’s take a look at some of the most common types of budgeting methods.
Types of budgeting methods
Activity-based budgeting records and tracks all costs related to the business. After identifying activities that create costs for your business, they are recorded and analyzed to give you insights into where money goes. This type of budgeting follows a top-down approach, meaning that you set a budget and it determines how funds are allocated. For example, if the budget allocates a certain amount to one department, that department must determine how best to spend that exact amount of money.
One of the goals of activity-based budgeting is to keep costs as low as possible. Rather than adjusting a budget for inflation or basing it on a previous year’s budget, this method focuses on efficiencies and maximizing opportunities. This is considered more rigorous than a traditional budget and is often employed by new businesses and companies undergoing significant changes.
Incremental budgeting is a process where a budget is created by iterating on the budget used in the year prior. This method takes the last full year’s budget and adds or subtracts a percentage to plan for the current year’s budget and goals.
This method does not take into account line-by-line costs or in-depth analysis, which can mean you miss opportunities to cut costs. However, this more streamlined and simple budget style can be a good fit for businesses that change little year over year. Any changes to the budget are easier to spot using incremental budgeting. They are commonly used by educational institutions and other large organizations.
Value proposition budgeting
Value proposition budgeting, also known as priority-based budgeting, focuses on the value of every item on an expenditure list. Ask yourself these questions when creating a budget using the priority-based budgeting method:
- Why is this amount included in the budget?
- Why are we spending this money?
- Does the item create value for customers, staff, or other stakeholders?
- Does the value of the item outweigh its cost?
This budgeting method strives to identify value and highlight opportunities to cut expenses that don’t draw value for the business.
Former Texas Instruments account manager Peter Pyhrr pioneered zero-based budgeting in the 1960s. Unlike more traditional budgeting methods of the time, each year’s budget starts from scratch rather than making an increase or decrease based on prior years.
Using this budgeting method, you allocate all of your money to expenses, savings, and debt payments. This budget method sets aside money for specific functional areas of the business. This can help lower costs by knowing the intended purpose of money spent. The goal of this budget is for your income, minus all expenses, to equal zero.
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Some budgeting tools to consider
Creating a budget can be a great way to get a quick lay of the land for your business. As your business scales, consider adding some additional tools to maintain and manage your budget.
Use budgeting software: Budgeting software can help you track and manage your business’s budget. QuickBooks, Hurdlr, Xero, and Zoho Books are among many companies that can help you manage your budget, and they integrate with Square.
Consider hiring a professional: You might engage a range of professionals, from accountants to budget analysts, to help you create and manage budgets.
As your business grows in size and complexity, you may want to work with a financial professional to help you plan ahead for your business.
These are a few budgeting tools and methods businesses use to manage cash flow better.