- Budgeting in Finance
- What is Budgeting?
- Budgeting Examples
- Master Budget
- Absorption Costing
- Variable Costing vs Absorption Costing
- Activity Based Costing
- Product Cost
- Product Cost Examples
- Period Costs
- Period Cost Examples
- Incremental Costs
- Variable Costing
- Semi Variable Cost
- Period Cost vs Product Cost
- Incremental Revenue
- Fixed Cost Examples
- Average Cost vs Marginal Cost
- Job Costing vs Process Costing
- Variance Analysis Formula
- Budgeting vs Forecasting
- Traditional Budgeting vs Zero Based Budgeting in Finance
- Fixed Budget vs Flexible Budget
- Zero Based Budgeting
- Traditional Budgeting
- Budgetary Control
- Flexible Budget
- Capital Budgeting Importance
- Purchasing vs Procurement
- Cost Center
- High-Low Method Formula
- EOQ Formula
- Accounting Basics (80+)
- Bookkeeping (52+)
- Balance Sheet (30+)
- Assets (109+)
- Liabilities (68+)
- Shareholders Equity (91+)
- Income Statement (158+)
- Cash Flow Statement (17+)
- Accounting Careers (27+)
- Accounting Books (8+)
What is Traditional Budgeting?
Traditional budgeting is a method of budgeting which depends on the exact preceding year’s spending to do the budgeting of the current year.
The only benefit of going for this sort of budgeting is simplicity. If a company follows this type of budgeting, they don’t need to rethink over every item on the list. Rather they can simply look at the spending of the previous year and then add/deduct inflation rate, market situation, consumer demand etc.
Most people and companies prefer this type of budgeting because they can sit with whatever data they have with them and then they can create a budget quite quickly.
Traditional budgeting is very common since it saves time and if you can be incremental in your approach, you can quickly figure out how much you may need to spend as a company/individual. If you go back and think how you budget your expenses you will see that the general tendency is to look backward and see how you have spent your money.
Most people look back and take the previous year as a base for setting a budget for their spending/income. While making the budget, they consider few factors which they think may affect their spending or income. These factors can be controllable or sometimes uncontrollable.
Advantages of Traditional Budgeting
The advantages of traditional budgeting are as follows –
- Offers a solid framework: Since it is based on a reference point (the data points of the previous year), it becomes easy to manage the financial activities of the organization. Alternatively, this reference point allows the company to base their budget on a solid framework which is easy to execute and easy to control.
- Encourages decentralization: Since everyone can look at the preceding year’s spending and can decide upon the budget for next year, the idea becomes decentralized. And the top management doesn’t need to think about how to budget for the next year. And as a result, they can concentrate on other high value tasks.
- Traditional budgeting becomes part and parcel of organizational culture: Since it is the most simplistic method of budgeting, soon it becomes part of the organizational culture. And perpetually the method goes on and on and on. If the new method is introduced (for example “zero-based budgeting”) then it would be a risky endeavour for the business.
But traditional budgeting also has many disadvantages for which companies tend to move toward zero-based budgeting more than anything.
Let’s look at the disadvantages of traditional budgeting.
Disadvantages of traditional budgeting
Here are the major drawbacks of traditional budgeting –
- Chances of human errors are higher: Since it is all about looking at a lot of spreadsheets, it’s natural to err and make mistakes. As a result, sometimes the mistakes become too costly for businesses.
- Time-consuming: In traditional budgeting, managers depend on a lot of spreadsheets. As a result, it takes a lot of time to sort things out, to compare the previous year’s spending with the expected expenditure by adding the inflation and other factors.
- Doesn’t encourage expected behaviours: If a company wants to promote innovative and loyal behaviours, the companies should put in more budget into those departments where the employees regularly innovate and think of organizational goals first. But in this budgeting, the expected behaviours can’t be encouraged as it depends on the spending of the previous year.
- No alignment between spending and strategy: Every year’s strategy is different since every year every organization wants to reach higher. With the similar spending scenario, it would be impossible for an organization to a strategist for a year to year profits and development.
- Inaccurate predictions: Since it takes preceding year’s data points as base points, the budget predictions for next year can’t reach accuracy. How can one year be just like the previous year? It’s always wise to revisit the factors, look at the strategic plans of the future, and then go ahead and budget the spending of the next year. Without proper thinking and the right approach, ensuring accuracy is almost impossible.
Does traditional budgeting work?
The short answer is – not ideally. But yes, if you are a small firm and you don’t have many overheads to include into your budget, then you may choose traditional budgeting. Though, zero-based budgeting can be way more superior to traditional budgeting since you can think about the next year with a blank slate.
So given the choice between traditional budgeting and zero-based budgeting, any firm irrespective of the size or revenue should go for zero-based budgeting without a tinge of doubt. The only exception is the firm which has issues with centralized process and adapting to change.
This has been a guide to what is traditional budgeting and its advantages and disadvantages. We also answer whether traditional budgeting works? Also, you may have a look at these articles below to learn more about budgeting –
- What is Flexible Budget?
- Disadvantages of Incremental Revenue
- What is Incremental IRR?
- Why Zero Based Budgeting Concept?
- Budgeting vs Forecasting Differences
- Traditional vs Zero Based Budgeting Differences!
- Fixed Budget and Flexible Budget Differences
- Cost Accounting vs Management Accounting Differences