Traditional Budgeting

Last Updated :

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Blog Author :

WallStreetMojo Team

Edited by :

Ashish Kumar Srivastav

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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What is Traditional Budgeting?

Traditional Budgeting is one of the methods used for the preparation of the budget by the company for the specific 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., the current year budget is made by making changes in budget of last year.

Traditional budgeting is a method that depends on the same year's spending to do the budgeting for 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 look at the previous year's spending 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 a few factors that may affect their spending or income. These factors can be controllable or sometimes uncontrollable.

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Traditional Budgeting

Advantages

  • 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 organization's financial activities. 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 decide on 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 a new plan is introduced (for example, “zero-based budgeting”), it would be risky for the business.

Disadvantages

  • Chances of human errors are higher: Since it is all about looking at many 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, it should put 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 previous year's spending.
  • 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 be a strategist for year-to-year profits and development.
  • Inaccurate predictions: Since it takes the 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? Without proper thinking and the right approach, ensuring accuracy is almost impossible. It's always wise to revisit the factors, look at the strategic plans for the future, and then go ahead and budget the spending for the next year.

Does traditional budgeting work?

The short answer is – not ideally. Zero-based budgeting can be way superior to traditional budgeting since you can think about the next year with a blank slate. But yes, if you are a small firm and don't have many overheads to include in your budget, then you may choose traditional budgeting.

So given a choice between traditional and zero-based budgeting, any firm, regardless of the revenue size, 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.