Incremental budgeting

This is where the current budget and actual figures act as the starting point or base for the new budget. The base is adjusted for forecast changes to, for example, the product mix, sales volume, sales price, expenses and capital expenditure that are expected to occur over the next budget period. It is called incremental budgeting as the approach does not focus on the base, but focuses on the increment (the changes from the base). An example would include increasing last years operating expenses by the rate of inflation to calculate the new budgeted figure. The major disadvantage of this is that the major part of the expense (the base) does not change and in fact is overlooked and not questioned under this approach. For example the base figure may be distorted due to extraordinary events in the previous period which are not expected to reoccur. Thus if this is not taken into account, the budget could be misleading.

Zero-based budgeting

This approach requires that every year, all costs and capital expenditure are questioned and thus require justification and prioritising before any decision is taken regarding the allocation of resources. Thus a zero base is adopted which effectively means that both the base and the increment are questioned. In fact the whole activity that leads to the item of expenditure is questioned and requires justification. Zero-based budgeting changes the approach of traditional or incremental budgeting from focusing on changes in expense items from year to year, to an approach that looks at each department budget as if it were undertaking its activities or programmes for the first time. It requires a detailed justification and cost-benefit approach to each expense item in the department budget. It forces managers to prioritise activities and related expenses based on a value for money concept. In effect, it overcomes the limitations of incremental budgeting.

Its advantages include the following

• It fosters a questioning attitude to all revenues and costs in preparing operating budgets.
• It focuses attention on the value for money concept.
• It can help identify inefficient work processes and operations.
• It helps minimise waste.
• It should result in more efficient allocation of resources.

Its main disadvantages are that as an approach it is costly and time consuming and may require management to develop and learn new skills.

Many businesses do not apply a full-scale zero-based approach to their budgeting process but only apply it to selected revenue and expense items or departments within an organisation. These expense items would often include advertising, research and the costs associated with developing new products and product lines.

Activity based budgeting

Activity based budgeting (ABB) involves the build up of budgeted costs using an activity approach. All the activities that are undertaken in the organisation, function or department are defined, and costs attributed to that activity are established. Resources are allocated according to activity levels. ABB can be used in all types of organisations. For example, ABB in the front office of a hotel would involve ascertaining such activities as answering customer queries, processing a reservation, preparing a quotation and updating customer accounts. The costs of each activity would then be established and resources would be allocated based on the planned level of activity.

ABB is an extension of the zero-based budgeting approach and goes into far greater detail in identifying value and non-value activities. It can be more effective than zero-based and incremental budgeting because:

• It avoids slack that is often included in the incremental approach.
• ABB focuses attention on each activity, highlighting those that do not add value.

Rolling budgets

A rolling budget is a twelve month budget which is prepared several times each year (say once each quarter). The purpose of a rolling budget is to give management the chance to revise its plans, but more importantly, to make more accurate forecasts and plans for the next few months. When rolling budgets are used, the extra administration costs and effort of producing several budgets instead of just one, should be balanced with more accurate forecasting and planning.

The advantages associated with the use of rolling budgets are

• Budgets are reassessed regularly and thus should be more realistic and accurate.
• Because rolling budgets are revised regularly, uncertainty is reduced.
• Planning and control is based on a recent updated plan.
• The budget is continuous and will always extend a number of months ahead.

The disadvantages are

• Rolling budgets are time consuming and expensive as a number of budgets must be produced during the year.
• The volume of work required with each reassessment of the budget can be off-putting for managers.
• Each revised budget may require revision of standards or stock valuations which is time consuming.