Login to your new FMVA dashboard today.

Incremental Budgeting

A budgeting method that makes only a few marginal changes to the current budget

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.

 

Incremental Budgeting

 

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:

 

1. Simplicity

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.

 

Bottom line

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.

 

More Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Budget Holder
  • Capital Budgeting Best Practices
  • Imposed Budgeting
  • Zero-Based Budgeting

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career path.

 

Learn financial modeling and valuation in Excel the easy way, with step-by-step training.