Incremental budgeting is a significant part of management accounting. It involves making minor changes to an existing budget to have a new budget. The budget used for the current year act as a base for the following year's budget allocation. The assumption is that all the departments will work based on the current estimation, and in case of any addition, it will be in the next budget.
There is no specific approach to incremental budgeting, but it is crucial to have an incremental budgeting approach. The approach is that the previous budget will act as a starting point for the following year's budget.
What is Incremental Budgeting?
Incremental budgeting is a budgeting approach whereby a new budget is from making minor changes from the current budget. The current budget will adjust and add or subtract from the current amounts to have budgeted new quantities. The incremental budgeting process is a common and practical approach for many people.
Points to Note
The incremental budgeting process is based on:
All the allocation on the new budget is from the previous period.
Sometimes this approach can be misleading since it does not take into account some changing circumstances.
There are instances where people tend to spend up to the current budget to have a reasonable estimation for the next period. It brings about the spend it or lose mentality.
Incremental Budgeting Formula
With incremental budgeting, you will need to use the previous year's estimations to the estimated base for the current financial year. The next step is to look for any increase or decrease from the previous year and accumulate for the next year. This incremental budget model works well for large organizations since they have funds allocated and experience minor fluctuations. A good incremental budgeting example would be for educational institutions and organizations because of long-term funded projects.
Below are some of the incremental budgeting pros and cons:
Advantages of Incremental Budgeting
This approach is easy to use and does not need any complicated calculations. You can achieve it in numerous departments in a big organization since you do not need any complicated analysis.
With incremental budgeting, you have the guarantee of continued funding with no detailed funding requirement.
There are no considerable deviations in the budget year in and year out hence a stable budget. With this approach, there will be equality in the different departments because each department has the same amount.
When using the incremental budgeting approach, the changes are seen after implementation. It is an excellent process for companies that have little or fixed deviation on their budget.
Disadvantages of Incremental Budgeting
There are chances that managers may spend more on their budgets since funds may be readily available. It can lead to unnecessary spending that is not warranted.
Most of the time, the incremental budgeting approach leads to lack of innovation to reduce cost. Since the method works, it will be easier to remain constant.
This approach discourages higher spending from having the same budget the following year. Incremental budgeting can make the management believe in budgetary slack. The effect is building lower revenue growth with higher expense growth.
This budgeting approach can bring about a “disconnect from reality mentality”. It happens since the budgeting estimation could be different from the actual budget. It depends on the previous budget and not the projected requirements.
Incremental budgeting might be easy to implement and compute, but it does come with more limitations. The problem comes with a non-innovative mindset that is not suitable for most business industries. When you have challenges and need help with budgeting and payments issues, contact the GoCardless automated payment system. Find out how GoCardless can help you with adhoc payments or recurring payments.