Four Types of Budgeting Methods: Pros, Cons and Uses

Selecting an appropriate budgeting method helps optimize resource allocation and resource planning, enhance financial control, and support your organization’s unique goals. Understanding these four key budgeting approaches will let you tailor your budget to effectively meet both short-term needs and long-term business goals.

But choosing the wrong budgeting framework can lead to increased costs, missed strategic goals, and even financial instability – making it crucial you understand which budgeting types you should use for your specific business situation, ensuring you budget for business performance.

We’ve listed four key established budgeting approaches below, but you can also explore budgeting best practices.

When you're deciding on a budgeting framework, it's important to understand how each method aligns with your strategic goals. In this introduction, we'll explore how these methods cater to different financial planning needs.

Four Budgeting Frameworks

1. Activity-Based Budgeting (ABB)

Allocates funds based on activities that drive costs rather than historical spending.

Instead of relying on historical spending patterns, ABB focuses on the actual processes and tasks that generate expenses. A leading automotive parts manufacturer achieved a 20% reduction in operational costs through the adoption of activity-based budgeting practices. ABB allocates financial resources by identifying and analyzing the key activities that drive costs within an organization.

This method enhances cost transparency and budget variance analysis, promotes efficiency, and ensures budgeting aligns with the organization’s operational priorities and strategic goals.

Pros: Provides a clear link between costs and business activities, enhancing transparency.

Cons: Can be complex to implement and maintain due to detailed analysis required.

Ideal Use Case: Best for companies wanting to understand the cost drivers and improve cost management.

2. Zero-Based Budgeting (ZBB)

Zero-Based Budgeting begins each budgeting cycle from a base of zero, requiring every expense to be justified anew. Unlike traditional budgeting, which often adjusts previous budgets incrementally, ZBB demands a thorough evaluation of all costs. This approach promotes fiscal discipline, eliminates unnecessary expenditures, and ensures that resources are allocated based on current business needs and priorities.

Unilever reportedly saved approximately €1 billion between 2016 and 2018 through their zero-based budgeting implementation, which required justification for every expense from scratch at each budget period.

Pros: Promotes efficiency and optimal resource allocation by eliminating unnecessary spending.

Cons: Time-consuming and requires detailed justification for every resource.

Ideal Use Case: Best for organizations looking to cut costs and ensure every dollar spent is necessary.

3. Value Proposition-Based Budgeting

Allocates resources based on the value delivered to customers.

Value Proposition-Based Budgeting allocates financial resources based on the value delivered to customers, prioritizing spending on activities and initiatives that enhance customer satisfaction and drive value creation.

By focusing on the benefits provided to customers, organizations can ensure that their budgets support strategic objectives, improve service quality, and foster long-term customer loyalty.

Pros: Ensures spending aligns with delivering high value services or products.

Cons: Requires a deep understanding of customer value propositions and their financial impacts.

Ideal Use Case: Best for customer-centric organizations focused on maximizing value delivery.

4. Incremental Budgeting

Builds upon the previous years’ budget by adding or subtracting a percentage.

Building upon the previous year’s budget by making minor adjustments, the incremental method typically adds or subtracts a fixed percentage from certain departments or spend areas. This straightforward approach simplifies the budgeting process and provides stability by maintaining continuity from one period to the next. However, it may overlook inefficiencies and fail to address changing circumstances, making it best suited for stable environments with predictable financial needs.

Pros: Simple to implement and understand.

Cons: May perpetuate inefficiencies and not reflect current strategic priorities

Ideal Use Case: Best for stable organizations with predictable financial environments

How to Choose the Right Budgeting Method

We recommend evaluating your organization's strategic objectives, cost structure, and available resources before selecting a budgeting method. Consider how much time and detail you're willing to invest, the level of cost transparency needed, and your adaptability to changing business conditions.

Understanding Budgeting Methods for Better Business Efficiency

The best finance leaders adapt the relevant method to tailor it even further to their business. The worst thing you can do is implement Incremental Budgeting in a company that faces many changes, yet we see that quite often!

To learn more about budgeting methodologies, what an operating budget is, and even get a step-by-step budgeting guide, take a look at our complete guide to budgeting for business performance.

Conclusion

Choosing the best budgeting framework empowers you to allocate resources strategically, control costs, and align financial planning with your business goals.

By understanding the advantages and drawbacks of each method, you can create a more effective, flexible budget that supports sustainable growth and success.