What is Traditional Budgeting?
Traditional Budgeting is one of the methods used for the preparation of the budget by the company for the specific time period under consideration where the budget of the previous year is considered as the base using which budget of the current year is prepared i.e., current year budget is made by making changes in budget of last year.
Traditional budgeting is a method of budgeting that 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, it doesn’t need to rethink every item on the list. Instead, 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 about 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.
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For eg:
Source: Traditional Budgeting (wallstreetmojo.com)
Advantages
- Offers a solid framework: Since it bases 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 its budget on a solid framework that 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 following year. And as a result, concentrate on other high-value tasks.
- Traditional budgeting becomes part and parcel of organizational culture: Since it is the most straightforward method of budgeting, soon it becomes part of the organizational culture. And perpetually, the process goes on and on and on. If the new plan is introduced (for example, “zero-based budgetingZero-based BudgetingZero-based budgeting refers to the budgeting method whereby the expenses and income on the list start from zero. There is no reference point for the budget items, and each of these expenses is individually interpreted as per requirement.read more”), then it would be a risky endeavor for the business.
Disadvantages
- 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, 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 inflation and other factors.
- It doesn’t encourage expected behaviors: If a company wants to promote innovative and loyal behaviors, 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 behaviors 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 a 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 in 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 a 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 processes and adapting to change.
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This article has been a guide to what is traditional budgeting and its advantages and disadvantages. Do we also answer whether traditional budgeting works? Also, you may have a look at these articles below to learn more about budgeting –
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