Learn The Relevance Of Incremental Budgeting To Your Small Business

Incremental budgeting is a conservative form of financial forecasting dating back to the origins of domestic and national budget planning.

It is a fairly simple format to adapt to, but this page will show you how practicing its use will most likely save you money in the short run, but most likely constrain your competitive potential in the medium to long term.

Characteristics

Requires that Current level of activity and budgeted allowances are taken as a base.

In other words prepare the forecast using the previous period’s forecast or actual performance as a basis, then add incremental budget amounts that you expect to change in the new planning period.

Advantages of Incr. Budgtng

• The model operates under a stable and predictable system and any change will be gradual.
• Managers can operate their departments on a consistent basis.
• The system is relatively simple to operate and easy to understand.
• Conflicts should be easily avoidable if departments can be seen to be treated similarly.
• It is Appropriate where there is a large number of cost centres/budgets to calculate and forecasts do not change significantly from one year to the next
• Co-ordination between forecasts is easier to achieve.
• The impact of change can be seen quickly.

Disadvantages of Incr. Budgtng

• It assumes that activities and methods of working will continue in the same way.
• It allows no proper incentive for managers to develop new innovative ideas.
• Its normally on an upward trend, hence providing no incentive for managers to reduce costs.
• It encourages spending up to the budget limits so that future estimates are maintained next year.
• The forecast may become out of date and no longer relate to the level of activity or type of work being carried out.
• The priority for resource allocation may have changed ever since the prior estimates were originally set.
• May perpetuate past inefficiencies. In other words incremental budgeting does not cause serious challenge to the status quo of managers concerned because different methods of achieving performance objectives are not put to test
• There may be budgetary slack built into the estimates, which is never reviewed.
  In other words Managers might have overestimated their requirements in the past in order to obtain a forecast which is easier to work towards, and which will allow them to achieve favorable results.

Conclusion

Incremental budgeting is designed in such a way that allocation of resources is based upon allocations from the previous period.

It encourages managers to “spend up to the last cent” to ensure a reasonable allocation in the next period.

As a result, modern business practices have dictated that this approach should be discouraged among the recommended methods of financial planning. This is because it fails to take into account changing circumstances geared towards running businesses more efficiently.

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