The 4 Different Budgeting Strategies & What’s Right For You

In the early days of your business, it was probably pretty easy to create a budget - spend as little as possible. The sales may have been slow, expenses high, and you didn’t have any historical data to analyze, so you just tried to play things safe.

Then as time went on you began to consider things like cash flow and accounts receivable applications. The accounting was getting complex so you worked to simplify things.

Plenty of business owners find budgeting an easy thing to simplify. You rely on certain clients, build an emergency savings, and check our bank account whenever making a purchase.

However, this is a stressfully inaccurate way to build your business. Miscellaneous expenses can sometimes pop up. Income can fluctuate. Variable expenses are difficult to account for. There has to be a better way!

In fact, there are 4. In this article, you are going to dive into those different budgeting strategies and what’s right for you. 

Zero-Based Budgeting

Zero-based budgeting is a pretty common way to budget for a business. The catch? There is no budget. Instead, every expense is analyzed and approved by an upper level manager who determines whether the expense is absolutely necessary for the business. This can be an excellent way to cut non-essential expenses.

There are some challenges with this method of budgeting. The first being it can be very time consuming. Every expense needing approval from management makes it difficult to move projects forward at times. If research and development is occurring, it will be up to the spender's ability to explain to the manager why this expense is necessary.

Many businesses can switch to zero-based budgeting if they are experiencing financial hard times like a recession or pandemic. This will quickly weed out any unnecessary costs.

This is good for: Small businesses with few approval levels, few time constraints, and on an extremely limited budget.

Activity-Based Budgeting

If you are an optimistic business owner then this can be a great option for you.

Activity-based budgeting looks at the goals of the business. They then reverse engineer the costs it would take to get to those points and create a budget around those numbers. 

Let’s say a business wants to generate an additional $10,000 in income each month next year. To do this they would have to consider their expenses and what they would look like if they actually were generating $10,000 additional revenue.

A budget is then created to reflect those numbers.

This is good for: A business with an optimistic owner, established and realistic goals, and cash flexibility if those goals are not met. 

Profit First

The Profit First budgeting method was developed by the author, Mike Michalowicz. The idea is your budget fluctuates and is set by the income you made over a period of time. Then for every dollar you earn, it is broken down into various buckets. Once broken down, you have set your budget for the following period.

For example, let’s say your buckets are as follows:

Profit - 30%

Owner’s Pay - 20%

Tax - 10%

Operating Expenses - 40%

Then in period 1, you made $10,000. You would multiply your income in period one by the following percentages, which would set your budget for period 2. Your budget for period 2 would be as follows:

Profit - $3,000

Owner’s Pay - $2,000

Tax - $1,000

Operating Expenses - $4,000

The idea with profit first is that you are guaranteeing yourself a profit. Profit is included in your budget and the budget can easily fluctuate no matter how your business is doing. While this may affect your expenses, this is often the challenge. To keep your expenses within your preferred percentage. 

This budgeting method is highly personalizable and simple to manage.

This is good for: Busy business owners who struggle with establishing profit and fluctuating revenue. 

Incremental Budgeting

Incremental budgeting takes the actual numbers from the prior year then removes the appropriate percentage to achieve the new budgeted total. This is probably the most widely used budgeting method because it is easy to establish and attempts to find a fair way to meet goals. However, it does come with some cons.

Incremental budgeting does not consider the capacity of each category or department and whether they can reasonably cut back their spending. If an organization is finding they are scraping by and the budget is cut, they may be left without the proper tools needed to do their job. Meanwhile, another department may have more than enough in their budget.

This is good for: Business owners who have a good understanding of the capabilities of their departments and their spending but also need to cut expenses. 

As your business grows it is important to establish processes that support the growth of your business. Sticking with outdated methods will only slow your progress. Consider these budgeting strategies and which one is good for you as you begin to analyze your finances more.

If you are ready to work with an accountant to establish a budget for your business, consider scheduling a consultation with us here.