What is Incremental Budgeting?
Incremental budgeting is a type of a budgeting process that is based on the idea that a new budget can be developed by making only some marginal changes to the current budget. In other words, in incremental budgeting, the current budget is used as a base while incremental assumptions are added or subtracted from the base amounts to determine new budget amounts. Among all budgeting methods, the incremental budgeting is commonly considered as the most conservative approach.
Note that there is no standard formula to determine the applicable marginal changes in the budgeting process. The marginal changes are determined using assumptions on the incremental changes.
Advantages of Incremental Budgeting
Incremental budgeting can be appealing to some companies for a number of reasons, including:
Incremental budgeting is the easiest budgeting approach. Since it uses the budget for the current period to project the future budget, it does not require complex calculations. Also, only a few assumptions are required in the budgeting method. Finally, the method’s simplicity allows the company’s management to save time on the budgeting process.
2. Consistency and operational stability
The dependence on the figures from the budgets of previous periods ensures that the budgets remain consistent and relatively stable across time.
3. Funding stability
Incremental budgeting ensures that the funding remains stable over time. It may be helpful for companies with projects that require funding for multiple years.
4. Reduces internal rivalry
Incremental budgeting generally allocates equal incremental changes to the budgets. Thus, departments within a company do not need to compete with each other to obtain a larger portion of the budget.
Disadvantages of Incremental Budgeting
Despite its simplicity and consistency, incremental budgeting is frequently criticized for a number of underlying flaws. The key disadvantages of such a budgeting method are listed below:
1. Promotes unnecessary spending
incremental budgeting can result in unnecessary spending for a company. The reason behind it is that the departments within a company generally tend to spend all the money that they’ve been allocated in a budget to obtain a larger amount of money in the next period. Eventually, a company may encounter unnecessary spending.
2. Discourages innovation
Another key flaw is the prevention of innovative ideas and growth. Since new budgets are based on figures from previous budgets, there is a little room for the financing of new ideas or activities. Thus, incremental budgeting discourages the implementation of new ideas and fosters a conservative business environment.
3. Fails to account for changes and external factors
The key assumption behind incremental budgets is the constant stability of the company’s operations. Therefore, the budgets are not responsive to potential changes that can result from unforeseen circumstances or some unanticipated factors.
4. Lacks an incentive for a comprehensive review
The stability of incremental budgets does not provide any incentives to the company’s management for reviewing its budgets. The lack of a review process makes the budgets vulnerable to inadequate assumptions and mistakes.
Simplicity and consistency are the primary advantages of incremental budgeting. Nevertheless, the budgeting technique hides some flaws that can lead to adverse effects in the long term.
The conservatism of incremental budgeting, as well as its inflexibility to adjust to internal and external changes, impose many limitations on companies operating in today’s fast-paced business environment.
Generally, incremental budgeting can be applied only if you are confident that the company’s budgets will remain stable in the long term with only a few changes. In other cases, it is recommended to use more sophisticated budgeting techniques.
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