Advantages and Disadvantages of Incremental Budgeting

Question

What are the strengths and weaknesses of incremental budgeting?

Answer

Incremental budgeting involves altering the existing budget in added or subtracted small incremental amounts to determine the new budgeted numbers (Brown et al.). Budgets utilized in the current fiscal year serve as the basis for the forthcoming year’s budgetary allocations. Management assumes that each department continues to operate at or near their current level of expenditures with additional amounts subtracted or added to arrive at the next year budgeting estimates.

Preparation of budgets through incremental budgeting serves as an important tool in the management of a company. Incremental budgeting benefits the manager because of the ease in using this method, since the calculations involved are straightforward and simple (Brown et al.). This method of budgeting allows multiple departments to create budgets and ensures continuity of funding for each department without any detailed analysis (Brown et al.). Incremental budgeting method minimizes large deviations in the budgets from year to year, unless large capital expenses are required, creating stable budgets over time (Brown et al.). Companies utilize incremental budgeting to eliminate rivalry and/or establish equality among departments and where funding requirements remain fixed or with little deviation (Brown et al.). Year-to-year change can be viewed easily (Brown et al.).

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Although incremental budgeting provides easy computing and implementation and allows for steady budgets, this method presents several limitations. The assumption of this method establishes the budget for the approaching year will be marginally different from the budget for the previous year. However, this process fails to accommodate changes occurring within the company or from factors in the industry or the economy. Managers subconsciously encouraged to spend more within in a specific year to justify the budget or allocating funds for unwarranted purchases (Brown et al.). Incremental budgeting may lead managers into budgetary slack situations (Brown et al.), whereby they build lower revenue growth and higher expense growth to attain favorable variances. Actual expense and revenue results often differ from budgeted allocations since the budgets were developed upon a prior year benchmark and not from a forecasted projection (Brown et al.).

Companies often settle into a non-innovative, conservative mindset, since budgets allocated are essentially the same each year and departments avoid taking risks because required funding is unavailable (Brown et al.). Incremental budgeting ignores changes in efficiency or productivity in workers, leading to lack of innovation and providing little incentive for managers to employ cost reduction procedures/policies or implement new ideas (Brown et al.). Perpetual resource allocation often results with incremental budgeting, since the allocation of funds occurred in a previous year and the incremental budgeting process allocates similar amounts in coming years (Brown et al.). This perpetual allocation of resources causes a waste of resources or deprives other departments necessary funding requirements for innovations (Brown et al.).

Reference

Brown, M. T., Rascher, D. A., Nagel, M. S., & McEvoy, C. D. (2017). Financial Management in the Sport Industry. Routledge. New York, NY.