Types of budgeting models
/A business creates a budget when it wants to match its actual future performance to an ideal scenario that incorporates its best estimates of sales , expenses , asset replacements, cash flows , and other factors. There are a number of alternative budgeting models available. The following list summarizes the key aspects of each type of budgeting model.
Static Budgeting
Static budgeting is a budgeting method in which the budget is prepared for a single expected level of activity and is not adjusted after the period begins. The budgeted amounts remain fixed, even if actual sales volume, production levels, labor hours, or other activity measures differ from expectations. This makes static budgeting simple to prepare and easy to communicate, especially for stable operations with predictable costs. However, it can produce misleading variance analysis when activity levels change significantly, since some differences may reflect volume changes rather than performance issues. Static budgets are most useful for fixed costs, planned projects, and administrative spending.
Zero-Base Budgeting
Zero-base budgeting is a budgeting method in which each budget cycle starts from zero rather than from the prior period’s spending level. Managers must justify every proposed cost, activity, and resource request based on current needs and expected benefits. This approach can identify waste, outdated programs, duplicated work, and low-value spending that might survive under incremental budgeting. It is especially useful during cost reduction efforts or strategic realignment. However, zero-base budgeting requires substantial analysis, documentation, and management review, making it more time-consuming than traditional budgeting. It works best when applied selectively to areas with discretionary or controllable costs.
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Flexible Budgeting
A flexible budget adjusts budgeted revenues and costs to the actual level of activity achieved during the period. Instead of comparing actual results to a fixed budget based on one volume assumption, management recalculates the budget for the actual sales units, labor hours, machine hours, or other activity measure. This makes variance analysis more meaningful, because it separates performance issues from changes caused merely by volume differences. Flexible budgeting works especially well where variable costs move closely with activity levels. However, it requires reliable cost behavior estimates and a clear distinction between fixed, variable, and mixed costs.
Incremental Budgeting
Incremental budgeting is a budgeting method in which the current budget starts with the prior period’s budget and then adjusts it for expected changes. These changes may include inflation, wage increases, new contracts, volume changes, or management-approved spending reductions. The method is simple, familiar, and relatively easy to prepare because it does not require every cost to be justified from the beginning. However, it can also preserve inefficiencies, outdated activities, and unnecessary spending, since existing budget amounts are often accepted with limited review. Incremental budgeting works best in stable operations where costs are predictable and major changes are not expected.
The Rolling Budget
A rolling budget is a budget that is continuously updated by adding a new period as the most recent period is completed. For example, when one month ends, management adds another month to the end of the budget, keeping a constant planning horizon, such as twelve months. This approach keeps the budget more current than an annual static budget because it incorporates recent results, revised assumptions, and changing business conditions. A rolling budget works well in organizations with volatile sales, costs, or cash flows. However, it requires frequent data collection, review, and managerial discipline to avoid excessive administrative effort.
The Rolling Forecast
A rolling forecast is not really a budget, but rather a regular update to the sales forecast, frequently on a monthly basis. The organization then models its short-term spending on the expected sales level.
A key advantage of the rolling forecast is the ease with which it can be updated. Furthermore, no budgeting infrastructure is required, which keeps administrative costs at a minimum.
Evaluation of Budgeting Models
Of the budgeting models shown here, the static model is by far the most common, despite being unwieldy and rarely attained. A considerably different alternative is to use a rolling forecast, and allow managers to adjust their expenditures "on the fly" to match short-term sales expectations. Organizations may find that the rolling forecast is a more productive form of budget model, given its high degree of flexibility.
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