Many companies use incremental budgeting for their financial planning for a variety of reasons. Here are a few things to consider about incremental budgeting.
What Is Incremental Budgeting?
Incremental budgeting starts out with a budget from a previous period. The business uses this previous budget as a basis for calculating the new budget. They take the old budget and add to or subtract from the totals to come up with a budget for the upcoming period. For example, last year, a company did $1,000,000 in sales. For this year, they expect an increase in sales of 10 percent. Therefore, their new budget will be $1,100,000 for the year.
- Simplicity--This type of budgeting is very simple to understand. Compared to some of the other budgeting methods used in business, it is one of the easiest to put in practice. Therefore, you do not have to be an accountant or have much experience in business to use this form of budgeting.
- Gradual change--With this type of budgeting, you will have a very stable budget from one period to the next. This allows for gradual change within the company. Many managers are intimidated by large budget increases from one period to the next. With this type of budget, you will not run into this problem because it is based on the previous period's budget.
- Flexibility--This type of budgeting is very flexible. You can easily do it from one month to the next. This allows you to see change very quickly when you implement a new policy or budget.
- Avoid conflict--Companies with many different departments often run into conflict between departments because of their different budgets. With this method of budgeting, it is easier to keep everyone on the same page and avoid conflicts between departments.
- Does not account for change--This method is based on the idea that expenses will run pretty much as they did before. However, in business, this is rarely the case. There are always variables.
- No incentives--Such a simple method of budgeting really does not provide your employees with much reason to be creative. They have no incentive to innovate and come up with new ideas or policies. When a budget allows a little extra room for innovation, you might find that your employees come up with something great.
- Use it or lose it--Many employees view this as a "use it or lose it" system. They know that next year's budget is going to be incrementally based on this year's. Therefore, if they do not spend everything that is allocated to them, they may not have enough money to work with next year. This creates an environment where waste is encouraged.