Different Types of Budgets & Which One is Best for You

Unless you are fond of numbers, budgeting can be scary. 

But by understanding the different types of budgets, you can create a plan with the basics. If you have been thinking about saving money for your financial goals or dream vacation, we know it’s not easy. It may seem that before you can save a decent amount, it’s all gone to bills and miscellaneous expenses. However, there is a way out. We have learned that by learning a few simple types of budgets, you can draw up your own best system in a short time. Let’s dive into the simple types of budgets. We'll tell you a bit about each, who they work best for, and how to use the method to your advantage.

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Types of Budgets to Help You Save Money

The definition of a budget is a simple plan of action for your finances. As a beginner, working on a budget can be daunting. For this reason, we bring you simple systems for your everyday needs. 

Often a budget system makes you cringe at the thought of the calculations, some technical jargon, and definitions. To make it easy we start with the simplest types of budgets.

1. ​The Envelope System

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All you need in the envelope system is a simple process of allocating your expenses.

Definition of the Envelope System

If you have been trying to budget but without much success, then try the envelope system or the envelope method first. Because it is easy, it is one of the most widely used types of budget. Track your monthly expenses. Then divide them into categories depending on where you incur and how much cost you incur. The moment you receive a paycheck, allocate money as per your tracking into different envelopes for each category. By doing so, you now work within the fixed cash earmarked for each group for the entire month.

Who can use it?

It is a common practice in most households to use the envelope method since it does not require a lot of tracking. So, if you are a stay-at-home entrepreneur or someone just starting their career, you can begin small by allocating cash in different categories. 

How do you use it?

For instance, let’s say that you have expenses categorized into groceries, bills, entertainment, and education. Based on your past expenditures, allocate fixed cash into each envelope and work within the budget. If for any reason you wish to add new categories, then keep the money in the fixed expense first and then let the excess go into the new category.

What is the advantage of the Envelope System?

One of the significant advantages here is that it is easy to use even for young adults. There are no complicated calculations. To add to it, you do not work on extended credit instead of on fixed cash, so you don’t over exceed your budget.

2. ​Reverse Budgeting

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The reverse budget focuses on savings instead of expenses, and in comparison to the envelope method can be more effective.

Definition of Reverse Budgeting

Unlike the envelope budget, reverse budgeting is about working backward. It helps with money management by saving rather than tracking the expense. Even though it may not sound vastly different, it indeed is. 

When you focus on saving it is keeping track of your saving goals and giving it the due priority. Thereby you first release your paycheck funds for your savings and the rest can be set aside for the expenses.

Who can use it?

If your expense money is always falling short and you cannot find a way to save, try reverse budgeting. If you are an impulse buyer, then you might be hesitant to try this method. But if you have big plans for a house, luxury vacation or fancy car then you must curb the impulse buying. You may not be able to spend a lot, but the savings will help you meet your goals.

How do you use it?

Keep a sufficient amount of money for your savings. These savings could be a short or long term or both. Once you have allocated into savings, the remaining can be kept aside for your expense.

What is the advantage of reverse budgeting?

In reverse budgeting, you can save a decent amount for your goals. The total collected after some time will be of sufficient quantity than when you follow the envelope method, or no method at all.

​3. The Activity Based Budget

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Activity Based budgets work on the principle of research based on specific actions that incur costs. This is commonly used by certain businesses.

Definition of Activity Based Budget

In business, many activities are a cost to the company. These activities are studied to understand if the prices are indeed valid and if they should be included as part of the budget.

Since businesses usually indulge in calculating previous years cost and drawing a budget for the current financial year, prices are known in advance. However, validating such expenses and their need is prioritized in activity-based costing.

Who can use it?

Eliminating unwanted costs is vital for business with a best budget system. Hence of all the types of budgets, activity-based budgets is best for you if you run a small, medium, or large scale business. However, if you do not have the previous year’s activity cost, you can assume certain discretionary expenses and monitor their relevance over the year.

How do you use it?

Suppose you have an administrative, human resources, infrastructure and many other departments, in addition to miscellaneous costs. First, identify their role in the business. An in-depth study into the expense of the activity versus returns and profits can yield a relevant outcome. This will help determine whether it's worth carrying forward in the activity based budget.

What is the advantage of an activity-based budget?

As a business owner following types of budgets like the activity-based budget keeps your costs in control. You can trim down expenses when not required and instead utilize it for incremental returns.

4. Incremental Budget

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In an incremental budget, you add in increments to the previous year’s budget.

Definition of Incremental Budget

In the incremental budget, you take the last year’s budget and add small increments. It is done to have an approximate idea of the costs and add a certain percentage to the budget. For a company having surplus funds, this can work well. It is not complicated and easy to add small increments to functional activity that requiring funds.

Who can use it?

It is a budget system that every business can implement to project costs based on the prior year while accounting for increases. It does not involve in-depth study and is easy to carry forward every year.

How do you use it?

Take the previous year’s budget. Look at each function and add increments as needed. If required, check specific purpose which might not need increase and thus should only be carried forward if completely necessary.

What is the advantage of an incremental budget?

In an incremental budget, you don’t have to do complex calculations. Instead, you merely carry forward the calculations with small increments or reductions if needed. It is a great way to project possible expenses with a reference from last year.

5. ​Zero Based Budgets

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The approach here is to consider zero budgets for all activities. This method is a bit more advanced than others previously mentioned.

Definition of Zero Based Budgets

Zero-based budgets do not consider the previous year’s budget. Instead, each cost is investigated for each function, and the zero budget approach is taken. If the value after the study is valid, it is added to the budget. Unlike the activity-based budget, this is not based on the activity but the zero cost of every functional budget. It is done to assume zero cost for the period and start afresh without any carry forward costs that cannot be justified.

Who can use it?

In business, if your costs incurred are more than the profits, you need to reassess different aspects of business like the types of budgets. But going into granular detail can be difficult. Instead look at the new zero-based budget to scrutinize each activity and get the desired result.

How do you use it?

After analyzing all activities, if there is unusually high cost, then you can consider reducing the charges or outsourcing it accordingly. Implementation allows a fresh take on your investment.

What is the advantage of a zero-based budget?

The advantage of zero-based budgets is that no recurring cost is intentionally incurred for the period. Unrequited costs can be reduced or avoided in the next period cycle.

6. ​Value Proposition Budget

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Value proposition involves judging the value of the item included in the budget. In it, the reasoning for the inclusion of an object is decided.

Definition of Value Proposition Budget

The value presented by each item determines value-based pricing. There is a judgemental decision taken where the activity or the relevance of an item is vital. If there is sufficient value in the product to add to the final business profitability, then it can be a valuable part of the budget.

Alternatively, if the value is not substantial, then the item can be excluded from the value proposition budget. These can be subjective but are also based on business facts.

Who can use it?

A value-based proposition is usually done at the top level. While it helps in strategic decisions in large organizations, it is equally useful in medium organizations that use detailed planning.

How do you use it?

Pick an item in the budget. Examine it and assess any issues. For instance, recurring manufacturing costs but low output. Identify the reason for the low production. Is it a genuine reason? Or are there unexplained lapse? By judging the exact cause, you create a value proposition for the inclusion or exclusion in the budget.

What is the advantage of value proposition budget?

Even the slightest slip in any production, operational or administration or sales systems can be judged with the value proposition budget. Rather than just blindly throwing money at an expense, a thorough look at its necessity is taken into account.

Learning these types of budgets can be the first step to a significant financial year.

Saving money and cutting costs can be hard, but with a little practice and patience, you can master these different types of budgets in a short time. We hope this article can be a starting point for a significant financial year for you!

Which of these types of budgets do you use? Let us know in the comments below. If you know of anyone who wants to streamline their finances, share this list with them!

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