Incremental Budgeting - definition & overview

Incremental budgeting is a budgeting method that takes into consideration the previous period's budget and adds or subtracts a certain percentage to derive the current period's budget. This method is widely used due to its simplicity and convenience. However, it is important to note that while this method may be easy to implement, it may not always lead to the most efficient allocation of resources.

For small businesses, incremental budgeting can be a practical approach, especially for those with stable and predictable operations. It allows for steady growth, keeping in line with historical data and trends. It is a method that promotes stability and continuity, reducing the risk of drastic changes and potential financial instability. However, it is also essential to understand its limitations and consider other budgeting methods as the business grows and evolves.

Understanding Incremental Budgeting

Incremental budgeting is based on the assumption that the future will largely mirror the past. Therefore, it uses the previous period's budget as a base and makes adjustments based on expected changes in the upcoming period. This method is often used in organisations where operations and costs are relatively stable and predictable.

However, this method can lead to inefficiencies as it doesn't encourage critical evaluation of each line item. It may perpetuate outdated or unnecessary costs, and it may not respond quickly enough to changes in the business environment. Therefore, while it may be suitable for some businesses, it may not be the best approach for all.

Benefits of Incremental Budgeting

One of the main advantages of incremental budgeting is its simplicity. It is relatively easy to understand and implement, making it a popular choice for small businesses. It also promotes stability and continuity, as it avoids drastic changes in the budget from one period to the next.

Another benefit is that it requires less time and resources to prepare compared to other budgeting methods. Since it is based on historical data, there is no need for detailed market research or complex financial modelling. This can be particularly beneficial for small businesses with limited resources.

Limitations of Incremental Budgeting

Despite its advantages, incremental budgeting also has its limitations. One of the main criticisms is that it tends to perpetuate inefficiencies. Since it is based on the previous period's budget, it may continue to allocate resources to outdated or unnecessary costs.

Another limitation is that it may not respond quickly enough to changes in the business environment. For example, if a company's market share is rapidly increasing or decreasing, an incremental budget may not reflect these changes in a timely manner. This could lead to missed opportunities or potential financial risks.

Implementing Incremental Budgeting in Small Businesses

For small businesses considering implementing incremental budgeting, there are several steps to follow. The first step is to review the previous period's budget. This will serve as the base for the current period's budget. It's important to understand each line item and its purpose.

Next, consider any expected changes in the upcoming period. This could include changes in sales volume, cost of materials, or other operational changes. Adjust the budget accordingly, adding or subtracting a certain percentage as necessary.

Considerations When Using Incremental Budgeting

When using incremental budgeting, it's important to regularly review and update the budget. This can help to identify any inefficiencies and make necessary adjustments. It's also important to consider other factors that may affect the business, such as changes in the market or industry trends.

Finally, while incremental budgeting can be a useful tool for small businesses, it's important to consider other budgeting methods as well. Zero-based budgeting, for example, requires each line item to be justified for each new period, promoting efficiency and cost control. Activity-based budgeting, on the other hand, allocates resources based on the activities that drive costs.

Incremental Budgeting in the Context of Australian Small Businesses

For Australian small businesses, incremental budgeting can be a practical approach, especially for those with stable and predictable operations. It allows for steady growth, keeping in line with historical data and trends. However, it's also important to consider the unique challenges and opportunities that Australian small businesses face.

For example, the Australian market is often characterised by high levels of competition, particularly in sectors such as retail and hospitality. This means that businesses need to be agile and responsive to changes in the market. While incremental budgeting can provide a degree of stability, it may not always allow for the flexibility needed to respond to these changes.

Adapting Incremental Budgeting to the Australian Market

One way to adapt incremental budgeting to the Australian market is to incorporate a degree of flexibility. This could involve regularly reviewing and adjusting the budget based on changes in the market or business environment. This can help to ensure that the budget remains relevant and effective.

Another approach is to combine incremental budgeting with other budgeting methods. For example, a small business could use incremental budgeting for stable and predictable costs, while using zero-based or activity-based budgeting for areas of the business that are more dynamic and unpredictable.

Conclusion

Incremental budgeting is a simple and practical method that can be beneficial for small businesses, particularly those with stable and predictable operations. However, it's important to understand its limitations and consider other budgeting methods as necessary. By doing so, businesses can ensure that they are allocating their resources in the most efficient and effective way possible.

For Australian small businesses, adapting incremental budgeting to the unique challenges and opportunities of the Australian market can be key to success. Whether this involves incorporating a degree of flexibility, combining it with other budgeting methods, or regularly reviewing and updating the budget, the goal is to ensure that the budget supports the business's strategic objectives and drives its growth and success.