At its most basic level, a baseline budget projection builds on existing income and expense knowledge to make a future budget prediction. A business that's well established with at least a year of history can take advantage of this process, which can simplify budget preparation greatly. The alternative, called zero-based budgeting, requires wiping the slate clean and starting from scratch.
In a baseline budget, a manager gathers and reviews historical financial data and uses the year-end "actuals" as the baseline --- the beginning --- for the following year's budget. This can be applied to income and expense line items. The manager then makes adjustments to the numbers based on assumptions for the following year's activity. For example, if revenue has increased 10 percent per year every year for the past five years, a manager can reasonably assume that the trend will continue, assuming the same business conditions.
A business that has a very predictable operation may find that baseline budgeting removes a lot of aggravation from the budget process. It may improve the quality of the budget as it permits managers to focus on areas of difficulty or increasing activity. Careful analysis of prior year actuals often reveals patterns of "surprises" or areas that are perpetually under- or overfunded. This permits money to be allocated to accounts that need it more, which wastes less time and fewer resources.
The biggest disadvantage is that areas that may need review may get passed over year after year because of faulty assumptions; past assumptions may no longer be relevant to future operations. For example, if line items for travel or conferences are overfunded because employees are meeting with associates or training virtually, the underlying assumption is faulty. One way to eliminate faulty assumptions is to require not only careful review of line item revenue and expenditures, but also that updated assumptions should be provided along with the new year's budget.
Baseline Versus Zero-Based Budgeting
A manager who's considering changing the approach to his company's budget process should consider various factors before announcing such a change. A zero-based approach is a good idea if conditions have changed so much that the underlying assumptions for prior-year budgets no longer apply. This may occur if there's a new product or if an extraordinary one-time expense is due to occur in the upcoming year. A manager should also allow for more time to complete a zero-based budget and provide employees with the proper tools to analyze the data; zero-based budgeting is more complex, but it also requires an employee to justify routine activity that may feel a bit like reinventing the wheel.
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