What is Value Proposition Budgeting

What is Value Proposition Budgeting

Value Proposition Budgeting, also known as priority-based budgeting, is a costing method used to analyze the value of every activity in a business. This strategy prioritizes the most important activities to create better profits for the organization. 

Prioritizing high-valued activities will maximize profits. In addition, this budget process includes reasoning for allocating the budget for a particular project or activity. Reasoning the budget helps manage the essential costs first and creates a better performance image. 

Well-established companies use this budgeting method to evaluate their most profitable projects and develop the priority list accordingly. As a result, companies tend to settle for a higher budget for activities that generate the most revenue.

A value proportion budget uses the company’s historical data to estimate revenue and expenses. The company prioritizes higher income-generating endeavors and shifts most of its budget into them. Therefore, it is necessary to have accurate financial statements for value proportion budgeting to perform positively. 

With this method, we can determine what activities need more attention.

Value Proposition Budgeting vs. Zero-Based Budgeting

Value proposition and zero-based budgeting are two advanced methods of capital budgeting. Both require justification for the allocated costs and acquire qualities to generate higher income for the availing organizations. However, slight changes make them perfect for different business conditions. 

Value Proposition Budgeting

This budgeting method uses past performance data of the company to look for the highest ROI activities. Then, after prioritizing these activities, companies allocate a higher budget to generate better income.   

Zero-Based Budgeting

In a zero-based budget, companies do not use past performance. Instead, it starts the development of the funding from scratch with justification for every dollar involved. Budget allocation relies on the importance of a particular endeavor in the business structure. 

Advantages and Disadvantages of Value Proposition Budgeting

The purpose of a value proposition budget is to eliminate unnecessary costs and focus on projects that benefit the organization. Despite that, this process comes with a higher price and thorough planning before execution. 

Advantages 

  • This method creates a transparent window of the money transferred from department to department. Accounts manage and record regular cash inflows and outflows. 
  • Companies have the advantage of providing their highest ROI products or services with better advertisement and maintenance budgets to bring in more customers. 
  • The budget allocation process reduces the unnecessary cost paid to products or services that bring minimum or negative outcomes.
  • Companies can track the money spent and look for performance changes due to the expenditure.

Disadvantages 

  • Justifications for scenarios involving minor details or government intervention can become challenging to analyze
  • This method is a high-cost and time-consuming strategy that needs regular assessment. Companies may need to hire additional accountants to look after the budgeting process.
  • With the continuous global changes in political, economic, social, and technological aspects, there will be a need to change the allocated budgets consistently. 

Importance of Value Proposition Budgeting

Every company sticks to a budgeting plan to manage its regular expenses. Most companies rely on traditional budgeting methods. They use past performances of the company and the industry as the base for future budgeting decisions. However, new companies depend on value proposition budgeting to bring profitable growth with minimum funds invested.

 

For companies that want to underline their core performing products or what they are best at, they use value proposition budgeting. Whether you should put money into retaining or bringing in new customers, all parts come under value proposition budgeting. 

 

Companies with limited capital must use value proposition budgeting to eliminate unnecessary costs and focus on areas with a high return on investment

 

Developing a Value Proposition Budget for Business

To create a value proposition budget, accountants must analyze several components.

Availability of Data

A company’s historical data become the foundation of a value proposition budget—data availability and past appropriations help develop a solid budget.

Past Data Accuracy

Accountants must accurately prepare the historical data for the value proposition budget to perform well. Therefore, mistakes in the past data can negatively affect the prepared budget. This mistake will eventually cost the company much more than expected, creating negative cash flows.

Time Consumption

With all the perks of value proposition budgeting, one major drawback is the time it takes to progress. It is a lengthy process involving the entire project with assumptions on all the valuable activities. Several accountants and financial analysts work together to create this budget quickly. 

Finding Valuable Elements

Finding valuable elements is the most necessary part of value proposition budgeting. Analysts provide the board with all the products & services and the value they provide to the company. 

Eliminating Unnecessary Elements

After evaluating the most valuable products, analysts look for elements that create little value concerning the budget provided. Companies must recognize such aspects as they continuously offer negative cash flows in the capital account. 

Example of Value Proposition Budgeting

Let us look at an example of value proposition budgeting: 

There are two competing companies in the fast food industry. Company A reduces its marketing budget from $10000 to $3000. The remaining amount goes into research and development of the new product line. Company B understood the importance of marketing and increased its marketing budget from $10000 to $13000.  

After one year, the revenue of Company A declined to $140000 while Company B had a boost in sales, exceeding $260000. Although the change in marketing budget was limited, its impact on the companies’ sales was immense. 

This example examines the effects of marketing budget in the fast food industry. The primary part of value proposition budgeting is to prioritize those elements that generate the most significant value.

Final Thoughts

Value proposition budgeting is part of four primary budgeting methods used by finance professionals worldwide. The critical aspect of value proposition budgeting is finding what provides the company with the most value. 

Today, value proposition budgeting is an advanced method to prioritize projects or expenditures that help in the growth of the company. With value proposition budgeting, companies can avoid expense that does not add value to the company’s main objective.

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