Budgeting is a fundamental aspect of financial planning, and one approach that often comes up in discussions is incremental budgeting. It’s important to understand this method and how it might fit into your financial processes.
What is Incremental Budgeting?
Incremental budgeting is a budgeting approach where the starting point for a new budget is the previous one. Adjustments are then made—usually incremental increases or decreases—to reflect changes like inflation, market conditions, or organizational growth. This approach assumes that the existing budget framework is sound, and most changes will be minor refinements.
For example, if last year’s marketing budget was $100,000, and you anticipate a 5% increase in costs due to inflation, the budget for this year would rise to $105,000. It’s straightforward, predictable, and widely used by organizations that operate in relatively stable environments.
Why It’s Important to Understand Incremental Budgeting
If you’re in finance or manage a department’s budget, understanding incremental budgeting can help simplify your work.
Simplicity is Key
Incremental budgeting doesn’t involve starting from scratch every year. Instead, it builds upon what you already know. This simplicity makes it particularly appealing to organizations that don’t have the time or resources to overhaul their budgets annually.
Saves Time and Energy
Since you’re not re-evaluating every single line item, incremental budgeting is faster than methods like zero-based budgeting, where you start fresh each time. For busy finance teams, this efficiency can be a lifesaver.
Maintains Stability
Incremental budgeting offers a level of financial predictability. By tweaking an existing framework, you maintain consistency in spending patterns, which can be helpful when dealing with stakeholders who value stability.
Encourages Accountability
Since the budget builds on the previous year’s figures, departments are often held accountable for their spending trends. If expenses suddenly spike, it prompts a conversation about why those costs are increasing.
That said, incremental budgeting isn’t a one-size-fits-all solution. Its simplicity can sometimes be a drawback.
Pros and Cons of Incremental Budgeting
Before using incremental budgeting, it’s important to know its advantages and disadvantages.
Pros of Incremental Budgeting
1. Easy to Implement
One of the biggest advantages is its simplicity. Incremental budgeting is straightforward and doesn’t require a lot of training or technical knowledge. For organizations with limited financial expertise or time, it’s a practical choice.
2. Time-Saving
Because you’re not re-evaluating every expense line, the process is quick. Finance teams can focus on fine-tuning the budget rather than starting from scratch.
3. Consistency
By building on an established budget, you maintain a sense of continuity in your financial planning. This consistency can make it easier to track trends over time and ensure that long-term projects remain funded.
4. Predictability
Incremental budgeting allows for predictable adjustments. For example, if you know rent will increase by 3% annually, you can factor that in without much analysis.
5. Encourages Stability in Spending
By adjusting existing budgets rather than completely overhauling them, this method discourages drastic spending changes. Departments that are performing well can continue operating without significant disruptions.
Cons of Incremental Budgeting
1. Risk of Overlooking Inefficiencies
Since incremental budgeting assumes the previous budget is accurate, inefficiencies can easily be carried forward. For example, if a department overspent last year on unnecessary travel expenses, those costs might persist without proper scrutiny.
2. Encourages the Status Quo
Incremental budgeting can lead to complacency. It’s easy to fall into a routine of making small adjustments without questioning whether the budget aligns with broader organizational goals.
3. Lack of Flexibility
This approach works best in stable environments. If your industry is experiencing rapid change or if your organization is undergoing a transformation, incremental budgeting may not provide the flexibility you need.
4. Missed Opportunities for Innovation
Because the focus is on small adjustments, incremental budgeting doesn’t encourage creative problem-solving or bold investments. It’s not the best choice for organizations looking to shake things up.
5. Potential for Budget Creep
When budgets increase incrementally without a thorough review, it can lead to “budget creep”. Over time, these small increases add up, potentially leading to overspending.
How to Make an Incremental Budget
If you’ve weighed the pros and cons and decided that incremental budgeting fits your organization, here’s how to get started:
Step 1: Review Last Year’s Budget
The first step is to thoroughly examine the previous year’s budget. Look for patterns, overages, and areas where spending didn’t align with expectations. For example, if a department underspent significantly, ask why. Did they overestimate their needs, or were projects delayed?
Step 2: Identify Areas for Adjustment
Next, consider what’s likely to change in the budget in the coming year. Are salaries increasing due to cost-of-living adjustments? Is there a new project that requires additional funding? Identify these areas early to make informed decisions.
Step 3: Factor in External Influences
Think about external factors that might impact your budget. For example, inflation, market trends, or changes in regulations could affect costs. Incorporate these considerations into your adjustments.
Step 4: Consult Department Heads
Collaborate with department heads or team leads to get their input. They can provide insights into what worked well last year and where they foresee additional needs or potential savings.
Step 5: Apply Adjustments
Now it’s time to make your changes. Increase or decrease line items based on the information you’ve gathered. Be transparent about why these adjustments are being made, especially if they impact multiple teams.
Step 6: Review and Finalize
Once adjustments are made, review the budget with key stakeholders to ensure alignment with organizational goals. Make any necessary tweaks before finalizing.
Step 7: Monitor and Evaluate
Even after the budget is implemented, keep an eye on how it’s performing. Regular monitoring allows you to make mid-year corrections if needed.
A Balance of Simplicity and Analysis
Incremental budgeting is a practical and straightforward method that builds on your existing financial framework. It’s especially useful for organizations looking to save time, maintain consistency, and make predictable adjustments. However, it’s important to be mindful of its limitations, such as its tendency to perpetuate inefficiencies and discourage innovation. Remember, the key is to balance simplicity with thoughtful analysis to ensure your budget supports your goals effectively.