Types of Budgets: Their Weaknesses, Strengths, and Principles

Creating a budget is an effective way to help you avoid overspending. To do this, you can first learn about the different types of budgets, their benefits, and the principles you should keep in mind when preparing one. All of this information is available in this article. So, let's dive in and read until the end!

What is a Budget?

According to Investopedia, a budget is an estimate of income and expenses made for a specific period in the future.

This can be done by individuals, households, governments, or businesses, regardless of their income level. The purpose is to estimate how much money will be spent based on the income received.

A budget can help prevent overspending and cover necessary expenses. It is typically created for a specific period and evaluated regularly.

You can create a budget with pen and paper, spreadsheets, or versatile business apps like Labamu.

Types of Budgets

In this article, Labamu will focus on discussing the types of budgets commonly used by businesses. According to Bedford Consulting, here are some of the most frequently used types. Each of these budgets has its own advantages and disadvantages, which will be discussed in more detail below.

1. Traditional Budget (Incremental Budget)

This type of budget is created by following the budget from the previous period—usually with only slight adjustments to establish the new budget.

Advantages:

• Most commonly used, clear, and proven effective.

• Relatively easy to create because it’s based on the previous year’s budget.

Disadvantages:

• May perpetuate inefficiencies from the previous budget.

• Risk of being unadaptive to market changes or business environment shifts.

  
  

Best for: Business environments that are stable and companies that prefer a tried-and-tested method.

2. Zero-Based Budgeting (ZBB)

In contrast to incremental budgeting, zero-based budgeting is created from scratch each period—without considering the previous period’s budget.

Advantages:

• Encourages the review of spending inefficiencies, resulting in a more effective budget.

• Aligns spending with current situations and conditions.

Disadvantages:

• Requires more time and resources to prepare.

• Can be challenging to implement, especially for large businesses.

  
  

Best for: Businesses seeking a comprehensive financial review or those going through a restructuring phase.

3. Activity-Based Budgeting (ABB)

Activity-based budgeting is created based on the activities required to produce goods or services, tailored to the operational outputs.

Advantages:

• Allocates resources more strategically and according to priorities.

• Provides a detailed picture of resource allocation used.

Disadvantages:

• Can be complex and time-consuming, potentially hindering its implementation.

• Requires detailed analysis and understanding of processes and activities.

  
  

Best for: Companies that wish to align their financial plans with business activities or expected outcomes.ional atau hasil yang diharapkan.

4. Value Proposition Budgeting

Value proposition budgeting is a budget where expenditure priorities are arranged based on the return on investment (ROI) of activities.

Advantages:

• Focuses on activities that add value to the business.

• Prioritizes expenditures based on ROI-generating activities.

Disadvantages:

• Can be challenging because determining value can be highly subjective.

• May overlook essential functions that do not directly or immediately provide ROI.

  
  

Best for: Businesses that want to align their budgets with strategic goals and value creation.

5. Rolling Budget

Also known as a continuous or rolling budget, this type of budget is dynamic and updated regularly, such as monthly or quarterly, until the period is complete.

Advantages:

• Provides more flexibility and strategic alignment.

• Allows businesses to quickly adapt to changing conditions.

Disadvantages:

• Requires regular updates, which can consume significant resources.

• Tends to focus on short-term planning.

  
  

Best for: Business environments that change rapidly, making annual budgets inefficient.

6. Project-Based Budget

As the name suggests, a project-based budget is created based on specific projects, providing a more realistic and accurate estimate for each.

Advantages:

• Ensures financial alignment with ongoing projects.

• Allocates resources more effectively for each project.

Disadvantages:

• Not a holistic approach for the entire organization.

• Requires continuous updates to adjust to changing project requirements.

  
  

Best for: Businesses that run multiple projects simultaneously or those that are project-driven, where each project requires a separate, detailed budget.

7.Participatory Budget

A participatory budget (bottom-up budget) is a type of budget developed by each department or team, with contributions from the employees involved in the budgeting process.

Advantages:

• Involves various departments, leading to more realistic and diverse insights.

• Increases commitment to the budget.

Disadvantages:

• Can be a lengthy and time-consuming process.

• Risk of increased budget requests from different departments.

  
  

Best for: Businesses that aim to enhance internal engagement in the budgeting process and leverage insights from employees across departments.

8. Flexible Budget

The last type of budget is the flexible budget, where the creation process is adjusted based on the actual activity levels during a specific period.

Advantages:

• Can be adjusted according to actual operational activity, providing real-time financial clarity.

• Allows for direct comparison between actual performance and the budgeted figures.

Disadvantages:

• Requires a more advanced financial system.

• Can be more complex to prepare initially.

  
  

Best for: Businesses that operate with varying levels of activity or experience regular fluctuations in demand, such as seasonal businesses.

Principles in Budget Preparation

From the types of budgets mentioned, along with their advantages, disadvantages, and compatibility, there are several principles that you should understand when preparing a budget:

1. Use Appropriate Budgeting MethodsChoose budgeting methods that align with your business design, conditions, and activities.

2. Create the Budget at the Start of the Financial PeriodThe budget should be prepared at the beginning of the financial period so that it can be used as a control tool and to assess effectiveness and efficiency throughout the period.

3. Collaboration in Budget PreparationThe budget should be collaborative, including input and feedback from all stakeholders, such as employees, executives, departments, and management.

4. Comprehensive BudgetThe budget must be comprehensive, covering all aspects of financial activities, using realistic estimates for both income and expenditures.

5. Transparency in ManagementManagement should be transparent and open about the budget with all departments to improve communication and coordination.

6. Clear Financial and Monetary Goals Financial and monetary goals should be clear and well-defined before planning the budget.

7. Adaptability to ChangesThe budget should be adaptable to changing business situations, requiring companies to regularly monitor and adjust the budget as necessary.

   
   

Those are the types of budgets and the principles you should consider when preparing them. As for transaction records and administration, leave everything to Labamu.

With just one app, you can enjoy a variety of free and paid features to support your business operations. Join over 84,000 other entrepreneurs who are already using this app to manage their businesses. Download the app via Google Play or the App Store now, Sahabat Labamu!