2 Different Types of Budgeting

The most widely used types of budgeting include:

1. Fixed Budgeting: Zero Budgeting and Incremental Budgeting
2. Flexible Budgeting

While budgets are not forecasting per se, they are indeed very often based on future sales forecasts. In fact, budgets are very clear, specific and measurable targets for different departments and divisions in the organization to achieve in the near future.

Two different approaches to budgeting in details

Let’s take a look at each of different types of budgeting in details. The way in which business budgets are created and used largely depends on the firm’s business objectives and its corporate culture.

1. Fixed Budgeting

Both Zero Budgeting and Incremental Budgeting belong to Fixed Budgeting. Fixed Budgeting assumes that the actual level of output always remains at the same level as the budgeted level of output. If actual output fell or rose above the budgeted level, then this would lead to variances – differences between the actual number and the budgeted number in the budget.

Example 1: The budgeted output is 1,000 units and the budget cost of raw materials is USD200 per unit.

When the actual output is 800 units and the actual cost of raw materials is USD20,000 (USD180,000). The actual cost of raw materials is lower than the budgeted cost of raw materials. This should sound good right

However, Fixed Budgeting ignores the fact that the actual output of 800 units is 20% below budget. Producing 20% less products should lead to lower cost of raw materials by 20%, right? It is because when the actual output is 800 units, the actual cost of raw materials should be USD200 per unit).

Unfortunately, the actual cost of raw materials was USD20,000 (USD180,000). The actual average cost of raw materials is now USD0.



When is Zero Budgeting used?



Zero Budgeting will be used by business organizations that have an authoritarian corporate culture as they adopt tightly controlled budgetary systems.



✔ Advantages of Zero Budgeting: Zero Budgeting ensures that budgets do not grow automatically each year. It forces all departments and all budget holders to justify their budgets from scratch every single year. Hence, Zero Budgeting provides added incentive for the managers to defend the work of their own section. The budget holders are held accountable for all variances no matter how small these might be. Zero Budgeting also helps the business organization to identify areas that require large amounts of essential expenditure and those that require less. This will provide an opportunity to reflect on changing situations in different budget levels each year.



✖ Disadvantages of Zero Budgeting: Zero Budgeting is very time-consuming as a fundamental review of the work and importance of each budget-holding section is needed every year. Also, targets might often be imposed upon budget holders without any discussion or negotiation.