The 5 most common budgeting models explained

Budgeting Models

Whether you're refining your current approach or exploring new methodologies, this blog provides actionable insights to help you make informed decisions about your financial planning strategy. 

By understanding these budgeting methods, and their pros and cons, the benefit of Cloud-led financial software can become clear.

What is incremental budgeting?

Incremental budgeting is a time-tested approach that starts with the previous year’s budget as a baseline, adjusting for predictable changes such as inflation, new projects, or department needs. This method works best in stable industries with relatively consistent costs and revenue streams. 

Advantages: 

• Ease of implementation: Minimal analysis or debate is required, allowing quick budget creation.
• Predictability: By focusing on small, manageable changes, organizations can maintain consistency in operations. 

Disadvantages: 

• Potential inefficiencies: Carrying forward previous budget allocations may perpetuate outdated or unnecessary expenses.
• Lack of innovation: This method doesn’t encourage examining whether past expenditures still align with current goals. 

For example, a nonprofit organization focused on community health programs may use incremental budgeting to allocate resources for recurring initiatives like vaccination drives or educational workshops. 

Adjustments could include minor increases in staff salaries or supply costs while maintaining stable funding for core activities. This approach ensures continuity without overburdening the organization with complex budget re-evaluations every year. 

Click to read FP&A product brochure gated

What is activity-based budgeting?

Activity-based budgeting takes a more proactive approach by aligning financial resources with key organizational objectives. It focuses on funding the activities needed to achieve strategic goals rather than simply tweaking last year’s numbers. 

Advantages: 

• Goal alignment: Resources are directed toward activities that deliver measurable results.
• Strategic focus: This approach encourages leaders to think critically about how each dollar spent contributes to the organization’s mission. 

Disadvantages: 

• Complexity: Activity-based budgeting requires clear communication and collaboration to identify priorities and allocate resources effectively.
• Overemphasis on outcomes: It may underfund necessary but less visible activities, such as support functions or infrastructure maintenance. 

For instance, a technology startup launching a new product might use activity-based budgeting to allocate resources to research and development, marketing campaigns, and customer support teams directly tied to the product’s success. 

What is zero-based budgeting?

Zero-based budgeting demands a fresh perspective by starting from scratch each year, requiring every expense to be justified based on its necessity and value. While it’s one of the most rigorous methods, its benefits can be transformative. 

Advantages: 

• Eliminates waste: By justifying each cost, organizations can identify and eliminate redundant or nonessential expenditures.
• Promotes accountability: Leaders must explain how their budgets support organizational goals, fostering transparency and discipline. 

Disadvantages: 

• Time-intensive: Starting from zero each year involves detailed discussions and extensive analysis, which can strain resources.
• Risk of underfunding: Critical areas might be overlooked if they don’t immediately demonstrate measurable value. 

Consider a nonprofit organization with limited resources. Using zero-based budgeting allows it to focus funding on programs with the highest impact while cutting back on administrative costs that don’t directly support its mission.