Budgeting is crucial for business management. Along with determining the operational profitability of a business by forecasting income and expenditures, it is critical for predicting the cash flow, which is of vital importance for achieving financial sustainability. Besides, budgeting helps to make the right business decision and monitors the performance of the business. Keeping the importance of it in view, incremental budgeting is an effective technique to opt for budgeting.
So, read on to find out what it is and what are its advantages and disadvantages!
What is Incremental Budgeting?
It is a common method of budgeting employed by the business due to its simplicity and ease. This budget is prepared by making some marginal changes to the previous year’s budget or current budget. In simple words, incremental budgeting uses the current budget as a base by making some additions or subtractions, where needed, to determine the new budget as per the market situations. This method is considered a conservative approach for budgeting among others.
The marginal changes are figured out with the help of certain assumptions of the previous year’s budget and expenses.
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It can be favorable and attractive to many businesses based on the following reasons:
1) It is Quick and Simple
It is the simplest and easiest budgeting approach. As it takes help from the current budget to prepare the future budget. Besides, unlike other budgeting techniques, there are no complex calculations involved. Additionally, there are few assumptions required in this method. Consequently, the management team can save a lot of time while employing this budgeting technique.
2) It is Consistent and Stable
The figures taken from the previous budget make it consistent and stable.
3) Stability of Funds
This method allows stability of funds over time as with this method you can easily project the expenses. As a result, it creates ease for businesses that require funding for multiple years for different projects.
4) Reduce Internal Conflicts
It allocates equal incremental changes from the current year’s budget to the next years. Resultantly, it reduces the internal conflicts of the department within the company by mitigating conflicts that arise from getting a large portion of the budget.
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Instead of being simple, easy and consistent, it is widely criticised for some of its inefficiencies that include:
1) Increases Unnecessary Spending
It leads to unnecessary spending for a company. As the departments get money as per the allocated budget to get more amount of money for the next budgeting period. But incremental budgeting increases each part of the budget by a specific amount every year. However, some departments don’t need it, but they are provided with an increased amount as per the process. In this way, it can lead to unnecessary spending that makes it less efficient.
2) Discourage Innovation
This budgeting method hinders innovation and growth. As the new budget is based on the last year’s budget, there is little space for funding new ideas and activities. In this way, it discourages innovative ideas and creates a business environment that is conservative.
3) Ignores External Factor
The main aim of this budgeting is to stabilise the company’s operation. As a result, this budgeting technique is ignored external factors and potential changes that can lead to unforeseen circumstances and factors that are unpredictable.
4) Lacks Comprehensive Review
The incremental budgeting technique doesn’t allow the management of the company to review its budget to promote savings by reducing its expenditures. This results in mistakes, and inadequate assumptions that make this method vulnerable.
In conclusion, we can say that despite being simple and consistent, it is non-effective for the long-term success of the company. Its conservative approach and inflexibility create problems for the success of a company in this dynamic world. Typically, the incremental budgeting method best suits you if you’re sure that the company’s budget will not change in the long run other than the minor changes. In other circumstances, you’re advised to opt for a better budgeting method.
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Disclaimer: This blog provides general information on incremental budgeting.