Question

Name and define the different perspectives on what different people want to see out of a budget? Which perspective is the most important to you? Why?

Answer 1

There are four common types of budgets that companies use:
(1) incremental,
(2) activity-based,
(3) value proposition, and
(4) zero-based.
These four budgeting methods each have their own advantages and challenges. They are as follows:

1. Incremental Budgeting
Incremental budgeting takes last year’s actual figures and adds or subtracts a percentage to obtain the current year’s budget. It is the most common method of budgeting because it is simple and easy to understand. Incremental budgeting is appropriate to use if the primary cost drivers do not change from year to year.

2. Activity-based budgeting
Activity-based budgeting is a top-down budgeting approach that determines the amount of inputs required to support the targets or outputs set by the company. For example, a company sets an output target of $100 million in revenues. The company will need to first determine the activities that need to be undertaken to meet the sales target, and then find out the costs of carrying out these activities.

3.Value Proposition Budgeting

Value proposition budgeting is really a mindset about making sure that everything that is included in the budget delivers value for the business. Value proposition budgeting aims to avoid unnecessary expenditures – although it is not as precisely aimed at that goal as our final budgeting option, zero-based budgeting.

4.Zero-Based Budgeting
As one of the most commonly used budgeting methods, zero-based budgeting starts with the assumption that all department budgets are zero and must be rebuilt from scratch. Managers must be able to justify every single expense. No expenditures are automatically “okayed”. Zero-based budgeting is very tight, aiming to avoid any and all expenditures that are not considered absolutely essential to the company’s successful (profitable) operation. This kind of bottom-up budgeting can be a highly effective way to “shake things up”.The zero-based approach is good to use when there is an urgent need for cost containment, for example, in a situation where a company is going through a financial restructuring or a major economic or market downturn that requires it to reduce the budget dramatically.

The term “budget” tends to conjure up in the minds of many managers images of inaccurate estimates, produced in tedious detail, which are never exactly achieved but whose shortfalls or overruns require explanations. And that is what budgets are like for many smaller businesses. This wasteful way of using budgets overlooks important managerial objectives that budgeting can help achieve.

Zero-based budgeting is best suited for addressing discretionary costs rather than essential operating costs. However, it can be an extremely time-consuming approach, so many companies only use this approach occasionally.