Incremental Budgeting Explained: A Step-by-Step Guide for Businesses

What is Incremental Budgeting?

Incremental budgeting is a budgeting method where the current period's budget is prepared by making incremental adjustments to the previous period's budget. Essentially, you start with last year's budget and then add or subtract a certain percentage or amount to arrive at the new budget.

Step-by-Step Explanation

1. Begin with the Previous Budget: Take the finalized budget from the previous period (e.g., last fiscal year).
2. Analyze Changes: Identify any anticipated changes such as inflation, new projects, changes in costs, or company goals.
3. Apply Increments/Decrements: Increase or decrease each budget item accordingly, often by a fixed percentage or amount that reflects expected changes.
4. Review and Approve: The adjusted budget is then reviewed by management and approved or further modified as needed.

Advantages of Incremental Budgeting

• Simplicity: It's straightforward and easy to apply.
• Time-Efficient: Requires less time than zero-based budgeting, which starts from scratch.
• Stability: Provides budget continuity by building on previous budgets.

Disadvantages of Incremental Budgeting

• Inefficiency: May perpetuate unnecessary costs or past inefficiencies.
• Lack of Innovation: Does not encourage questioning existing budgets or encouraging cost-saving measures.
• Insensitivity to Changes: Does not adequately adjust for significant changes in the environment or business operations.

When to Use Incremental Budgeting

Incremental budgeting works best in stable environments where expenses and revenues don't fluctuate significantly. It's suitable for organizations seeking a quick budgeting process with minor changes year over year.

Summary

Incremental budgeting is a method of budget preparation that takes last year's budget as a base and adjusts it incrementally to reflect expected changes. While it is simple and time-saving, it may not encourage cost optimization or adaptability to change.