Incremental budgeting is a budgeting approach where the current year’s budget is based on the previous year’s budget, with incremental changes made to reflect anticipated changes in revenue and expenses. It involves adjusting the budget by a certain percentage or amount, usually based on historical data or expected changes in the business environment.
This approach is often used by organizations that have stable operations and relatively predictable revenue and expenses. It is a simple and easy-to-use budgeting method, as it requires minimal changes to the existing budget. However, it may not be suitable for organizations that experience significant changes in their operations or for those that need to make drastic budget adjustments.
Incremental budgeting allows for a more conservative approach to budgeting, as it focuses on small changes rather than radical shifts. It also provides a sense of stability and continuity, as it takes into account the organization’s historical performance and trends.
However, incremental budgeting has its limitations. It may lead to budgetary slack, where managers intentionally overestimate expenses or underestimate revenues to ensure that their budgets are not cut in the future. It can also result in inefficiencies, as it may not encourage managers to critically evaluate and prioritize their spending.
Overall, incremental budgeting is a commonly used budgeting approach that provides a simple and stable framework for budgeting. However, it should be used with caution and complemented with other budgeting methods when necessary to ensure a comprehensive and accurate budget.
Advantages of Incremental Budgeting:
- Simplicity: One of the primary reasons for its popularity is its simplicity. Organizations can easily determine the next year’s budget by making small adjustments to the current year’s figures.
- Stability: It provides a sense of continuity, as radical changes in budgets are rare. This can be advantageous in stable environments where operations don’t change much from year to year.
- Predictability: Since it’s based on historical data, there’s an element of predictability. Departments generally know what to expect in terms of resources.
- Reduced Conflict: The focus on marginal changes might lead to fewer disagreements among departments over resource allocation compared to other budgeting methods that necessitate justifying every expense from scratch.
Disadvantages of Incremental Budgeting:
- May perpetuate inefficiencies: If there’s wasteful spending in the current budget, this approach is likely to carry that forward.
- Not responsive to rapid changes: In dynamic environments, incremental budgeting might not be as effective, as it doesn’t necessarily account for significant shifts in the external environment.
- Lack of innovation: Departments might become complacent, knowing that they’ll likely receive a similar budget to the previous year with only slight modifications.
- May not align with strategic goals: If the organization’s strategy or objectives change, incremental budgets may not be shifted enough to support these new directions.
- May encourage spending: To avoid getting a reduced budget in the next period, some departments might spend all they have, even if it’s not necessary.
Process of Incremental Budgeting:
- Start with the current budget as the base.
- Adjust for known factors such as inflation, contractual pay rises, or other predictable changes.
- Add or subtract amounts based on specific departmental or organizational needs, decisions, or priorities.
- Obtain approval for the adjusted budget.
In conclusion, while incremental budgeting offers simplicity and predictability, it might not be suitable for all organizations or in all situations. An organization’s choice of budgeting method should align with its strategic goals, operational needs, and the external environment in which it operates.
Example of Incremental Budgeting
Incremental budgeting is a budgeting method that uses the previous year’s budget as a starting point and then makes small adjustments to it based on anticipated changes in costs or revenues. It is a relatively simple and straightforward budgeting method that is often used by businesses that are in stable industries or that have a good understanding of their historical costs and revenues.
Example:
A company’s marketing budget for the previous year was $100,000. The company expects that its marketing costs will increase by 5% in the coming year, so it will create an incremental budget of $105,000 for the coming year.
Here is a more specific example of how a company might use incremental budgeting to allocate its marketing budget:
| Expense | Previous Year’s Budget | Anticipated Change | Incremental Budget |
|---|---|---|---|
| Advertising | $50,000 | +5% | $52,500 |
| Public relations | $25,000 | +10% | $27,500 |
| Social media marketing | $15,000 | +0% | $15,000 |
| Other marketing expenses | $10,000 | +5% | $10,500 |
| Total | $100,000 | +5% | $105,000 |
In this example, the company is allocating the largest portion of its budget to advertising, which it believes is the most important marketing activity. The company is also allocating a significant portion of its budget to public relations, which it believes is becoming increasingly important. The company is allocating a smaller portion of its budget to social media marketing and other marketing expenses.
Incremental budgeting can be a useful budgeting method for businesses that are in stable industries or that have a good understanding of their historical costs and revenues. However, it is not a good budgeting method for businesses that are in rapidly changing industries or that are undergoing significant changes in their operations. These businesses may need to use a more strategic budgeting method, such as value proposition budgeting or zero-based budgeting.
Incremental Budgeting vs Zero-Based Budgeting
Incremental budgeting and zero-based budgeting (ZBB) are two different approaches to budgeting. Incremental budgeting starts with the previous year’s budget as a baseline and makes small adjustments to it based on anticipated changes in costs or revenues. ZBB, on the other hand, starts with a blank slate and requires each expense to be justified before it is included in the budget.
Here is a table that summarizes the key differences between incremental budgeting and ZBB:
| Characteristic | Incremental budgeting | Zero-based budgeting |
|---|---|---|
| Basis for budget | Previous year’s budget | Blank slate |
| Complexity | Less complex | More complex |
| Focus | Historical spending patterns | Efficiency and effectiveness |
| Benefits | Simple, straightforward, easy to implement | Forces managers to think critically about expenses, can lead to significant cost savings |
| Drawbacks | Can lead to inefficient spending, can be difficult to justify significant budget increases | Can be time-consuming and complex to implement, may not be suitable for all businesses |
Which budgeting method is better for a particular business will depend on its specific needs. Incremental budgeting is a good option for businesses that are in stable industries or that have a good understanding of their historical costs and revenues. ZBB is a good option for businesses that are in rapidly changing industries or that are undergoing significant changes in their operations.
