Budgeting is basically formulation of realistic plans for dispersing resources of a company. A company prepares different kinds of budgets and then reconciles them with the original outcomes. Sales budgets, purchases budgets and production budgets etc. are some types of budgets.
The purpose of this article is to define and explain the difference between incremental budgeting and zero based budgeting
Definitions and explanations:
An incremental budget as the name suggests is a budget prepared on the basis of previous budgets or previous actual performances with incremental values. This increment is added in both the revenue targets as well as resource allocation.
Zero based Budgeting:
Zero based budgeting is a budgeting method in which budgets are prepared from a zero base which means that for every new budget no previous data is considered and every function is analyzed for its individual needs.
Difference between incremental budgeting and zero based budgeting:
The key points of difference between incremental budgeting and zero based budgeting are given below:
Incremental budgeting technique is most commonly used budgeting technique because this technique is easily understandable by the management of a company. Additionally, it provides reasonable targets without incurring much cost to formulate it. Zero-based budgeting technique is more complicated and time consuming. Because, it is assumed that every task has to be allocated resources from scratch, therefore targets are not just revised but reevaluated.
2. Primary focus:
The primary focus of zero based budgeting is those activities that are most important for an organization. As this type of budgeting requires resources and time, it is used at strategic level to set budgets that are congruent with the vision of the organization. The primary focus of incremental budgeting are those activities that are day to day activities and do not require much expertise. Such budgeting can be applied at management and operational level where aims and variables do not differ very quickly for example sales, purchases etc.
3. Cost analysis:
Zero based budgeting minimizes the chances of risks and errors in an activity. This is because zero based budgeting technique evaluates every activity from base and mitigates the chances of non-value adding expenditure to occur. This results in enhanced effectiveness of operations and procedures. On the other hand, incremental budgeting does not exert much heed to the general processes involved in a task rather simply adds or subtracts according to the previous results, therefore it becomes difficult to identify wasteful expenses.
4. Resource allocation:
Both financial as well as human resources are required to make zero based budgets. Management of a company requires professional and relevant knowledge, experience and skills to prepare such budgets. However, incremental budgets are easy to prepare because they do not require specialist skills or knowledge. Managers with basic knowledge of the task can prepare such a budget.
5. Learning organization:
Zero based budgeting promotes a culture of learning and innovation in an organization. The main reason behind this is that the task has to be assessed from its foundation. This not only makes the systems more efficacious but also increases knowledge and information of management about the company’s processes. Additionally, it compels the management to update their understanding of business and to cover any competence gap by continued professional development. Incremental budgeting may promote such psychological boundaries which may make the managers conservative. As no much effort is required to produce incremental budgets manager apply minimum efforts required to prepare these budgets.
Incremental budget versus zero based Budgeting – tabular comparison
A tabular comparison of incremental budgeting and zero based budgeting is given below:
|Is complicated to understand and apply.
|Is simple to understood and can be applied with ease.
|Is prepared for vital and value adding activities.
|Is prepared for normal and unimportant activities.
|Detailed cost analysis is done so that any nonessential parts of a task can be avoided.
|Do not carry any detailed analysis and merely adds or subtracts variables from previous budgets or prior actual results.
|Financial and human resources are required to prepare zero based budgeting.
|Can be prepared with basic knowledge of budgeting.
|Encourages innovation and learning in the company.
|Do not promote new knowledge or improvement of tasks.
Conclusion – incremental budgeting vs zero based budgeting:
Budgeting is an important exercise in order to run businesses effectively. Budgets are not only prepared to set goals but also to appraise the performances of employees which is based upon how well an employee, a manager or a team has achieved its budget objectives. Budgeting is also vital to plan activities realistically. It allows companies to determine their available resources in advance and ensures that these resources are best spent to achieve strategic direction of the business. Zero based budgeting technique is mostly adopted by medium to large companies and for such tasks that are core to business, so that risks in such activities can be avoided or at least transferred. Incremental budgeting is usually used by small to medium companies or for such tasks that are part of day to day operations. Such tasks do not carry much risk and therefore do not require detailed analysis.