Budgets are an important tool for performance management for any business, even individual budgets. Budgets help management in planning, monitoring, and controlling performance measurements. In private businesses; the performance objectives are financial, quantitative in nature, and well defined, so the budgeting process is easier. Whereas, in the public sector the stakeholder objectives are often qualitative in nature, non-financial, and difficult to measure. The top management in any organization can take many approaches towards the budgeting process, the most traditional approach is the “incremental budgeting” method.
Definition of Increment Budgeting
In incremental budgeting, the process starts with the analysis of the previous period’s budgets. Past date from previous budgets or the actual performance is the base of the new period’s incremental budget. For new budget, any adjustments for the inflation, and additional activity costs then added to the previous budget, hence the name “incremental”. However, based on the variance analysis the budgets may allocate reduced costs as it is not necessary to only add the costs in the budget. The traditional budgeting approach is less focused on cost reductions. We usually plan the incremental budgets for one year.
A Marketing agency, employees a total staff 15 members and their total annual salaries are accounted for $ 1 million per year. The management decides to hire new staff for the digital marketing section, for an additional $ 0.5 million and also decides for a pay rise of 5% for the existing staff. The incremental budget amount for the next will be $ 0.5 (5% × 1.0) million + $ 0.5 million = $ 1.0 million. Hence the allocation of the staff salary in the budget for the next accounting period will be $ 2 million.
Budgets serve numerous purposes to any organization including planning, control, and monitoring. The approach towards selecting the budget approach depends on the objectives, entity type, and size of the entity for which the budgets are prepared. The Incremental Budgeting method is appropriate for the organizations where the costs are more static and objective are measurable in financial terms.
Benefits of incremental budgeting
- This is the most conventional approach towards budgeting
- It is easy to understand, hence requires no special skills
- The convenience of this method means a less costly process
- The decision making process is simple
- It suits the organizations where operations are more consistent and historic date is accurately available.
Limitations of incremental budgeting:
- Unlike modern budgeting methods like the Zero Based Budgeting (ZBB), there are no logical justifications for the incremental costs
- This approach doe not stress on the importance of eliminating inefficiencies
- Rewards and performances are irrational as they do not take into account for any new target setting as we commonly prepare the new budgets based on past datas
- The inefficiencies of the past budgets may continue in the new budgets
The incremental budgeting approach is the most conventional and easiest to adapt. It is less expensive and easily understood by management. However, no single approach can guarantee success alone; the limitations with incremental budgets can be reduced with adapting to the alternatives.