What Is Incremental Budgeting?
Incremental budgeting is when small percentage-based changes are made to the prior period’s budget information (typically from the last 12 months) rather than creating an entirely new spending plan each year. This method, often referred to as incrementalism budgeting, emphasizes making minor adjustments based on previous data to reflect current realities. Incremental budgets work well for companies with stable costs and revenue—such as many SaaS companies—because actual performance can be used to make only a few assumptions about future spending and revenue. Unlike other types of budgeting—like zero-based budgeting, for example—the incremental budgeting method only considers changes from one budget period to the next. It doesn’t necessarily reflect long-term goals or strategies. Incrementalism budgeting provides a straightforward way to adjust budgets with minimal disruption.
So, incremental budgeting doesn’t work for every business. But it might be best for you depending on your industry and business model.
Why Do Companies Use Incremental Budgets?
Traditional budgeting is an in-depth process conducted annually. Financial Planning & Analysis (FP&A) teams use the previous year’s performance and projected income, expenses, and goals to set budgets for every department or project. While this approach is a valuable tool for cost containment, it is also time-consuming. Zero-based budgeting may not be necessary for businesses with stable cost drivers, expenses, and outputs.
The incremental budget model is straightforward. Begin with your previous period’s budget lines and adjust them by incremental amounts—up or down—based on your performance. It’s an easy way to quickly create a plan for the year. Incrementalism budgeting is favored by many because it builds on actual performance data, minimizing the need for extensive forecasting and speculation.
Incremental Budgeting Pros and Cons
Advantages of Incremental Budgeting
Established businesses with predictable spending, who want more of the same in future periods, choose incremental budgeting for its simplicity and ease of use. Some of the pros include:
- Ease of Preparation:
If you have actual performance data from previous budgets, you have everything you need to prepare your new budgeting process quickly and easily. This simplicity is especially useful for small business owners managing their accounting. - Ease of Use:
You don’t need to be a CPA to create or understand an incremental budget. Incremental budgeting is a clear-cut style of planning spend and tracking progress throughout the year.
The benefits of incrementalism budgeting include its straightforward approach that simplifies the budgeting process. - Cost-Effectiveness:
If you’re using an accountant for your budget preparation, one advantage is that the process takes less time and is less expensive than more complex methods. This keeps overhead costs down while still providing a clear plan for the year.
Drawbacks of Incremental Budgeting
Is incremental budgeting right for every business? Like everything in finance, it depends. Incremental budgeting doesn’t take into account external factors or changes in the business. You might look to other methods if:
- Your cost drivers change considerably over time
- You work in a high-volatility industry
- You’re trying to cut costs or increase efficiency
There are several issues to consider before adopting incremental budgeting:
- Perpetuating Inefficiency:
Incremental budgeting is built on the assumption that your previous period’s numbers were solid. However, if departments have practiced unnecessary spending—such as buying overpriced supplies or maintaining unused software contracts on auto-renewal—the new budget will continue to support these inefficiencies. A drawback of incrementalism budgeting is that it can sometimes perpetuate inefficiencies from previous periods. - Creating Budgetary Slack:
Department performance is often partly measured by budget performance. With an incremental budget system, a budget pool might provide teams with more money than they need, creating the impression that they “always come in under budget.” This stealth inefficiency reduces cash optimization. Since the budget is always based on previous data, budget inflation may persist for years. - Ignoring External Impacts:
Inflation, supply chain costs, and employment market changes significantly impact spending. A straightforward incremental budget often fails to account for these external forces. - Limiting Future Change:
As the saying goes, “What got you here won’t get you there.” Businesses intent on growth and expansion may not benefit from incremental budgeting because the process is built around stability rather than innovation.
Incremental Budgeting Examples
Incremental budgeting works for a variety of business strategy use cases. As one of the most commonly used approaches to budgeting, here are a few common examples:
- Salary Increases:
If a company typically gives salary increases around the same percentage each year, an incremental budget would factor in this expected increase based on the previous period. - Marketing Budget:
While it typically makes sense to compare marketing budgets to the year or period prior, it also makes sense to allocate a certain percentage increase to account for inflation or new initiatives. - Employee Benefits:
Adjustments for premium increases on health insurance or changes to retirement contribution plans make employee benefits an excellent example of incremental budgeting in action. These examples illustrate the principles of incrementalism budgeting in practice.
Which Budgeting Method Should I Consider?
There are two major incremental budgeting methods: top-down and bottom-up.
- Top-Down Budgeting:
In this approach, senior management makes decisions on the budget and communicates those expectations to department leads. The assumptions are based on past performance, the current period’s budget, and the organization’s future goals. - Bottom-Up Budgeting:
Conversely, in this approach, department managers build a recommended budget based on their strategic goals for the year. They then submit their budget assessments to senior management for approval and implementation.
In both approaches, companies use past performance and current budget data to make reasonable predictions about future spending and performance. Whether you choose a top-down or bottom-up approach, incrementalism budgeting remains a key consideration.
Four Methods to Budget for Your Business
There are four main methods companies use to plan their spending, each offering different advantages and disadvantages. Your chosen method depends on your business’s complexity, planning needs, and desired outcomes.
- Incremental Budgeting:
Great for companies seeking stability in their expenses and wanting to avoid unnecessary spending, this method relies on past performance to make adjustments. - Activities-Based Budgeting:
This top-down process allocates resources based on the activities that need to be completed, considering the cost of materials, labor, and other associated expenses. It is useful for streamlining costs by analyzing each action a company takes. - Value Proposition Budgeting:
Here, companies analyze the cost versus benefit to identify which activities provide the most value and where resources should be allocated. This method is useful for optimizing offerings and creating more business value. - Zero-Based Budgeting:
This bottom-up approach requires that all expenses be justified for each new budget period. Every expense is analyzed and allocated based on its contribution to the organization’s objectives. Among the various budgeting techniques, incrementalism budgeting is noted for its simplicity compared to more complex methods.
How Do You Create an Incremental Budget?
If you’ve decided that the incremental budgeting process is the way to go, follow these three steps to get your budget right the first time:
- Collect Your Actuals from the Previous 12 Months:
Start by gathering data on the last year of business. Include a complete list of costs:- Fixed Costs: Rent, wages, utilities, tax payments, loan repayments, software licenses, business licenses, and other predictable, recurring costs.
- Variable Expenses: Consultant fees, variable bills (like mileage or transportation costs), bonuses, overhead expenses, and other fluctuating categories.
- Make Adjustments Based on Previous Budgets, Data, and Assumptions:
With your actuals collected and categorized, adjust your previous budget numbers based on known or anticipated changes. For instance, if inflation drives up the cost of certain items, adjust the current year’s budget accordingly. If you plan to invest more in marketing, factor that increase into your new budget. Following these guidelines will help you effectively implement incrementalism budgeting in your organization. - Track Changes Over the Year:
Just because you build your budget annually doesn’t mean it’s “set it and forget it.” Tracking changes throughout the year allows you to compare actuals against your budgeted expectations. This comparison helps identify areas where costs have increased or decreased, any instances of overspending, and other discrepancies. Regular tracking will refine your assumptions and inform the percentage adjustments for the following year. Regularly comparing actuals to planned figures is a core principle of incrementalism budgeting.
Using Software for Incremental Budgeting
Implementing an incremental budgeting process does not have to be done entirely manually. Many FP&A teams use software solutions to accelerate the process and enhance the strategy behind incremental budgeting. Modern financial software can manage multiple scenarios of your budgets and provide transparency into how your numbers change over time. This approach eliminates the need to manage separate files for each scenario and helps prevent accidental overwriting of previous iterations. Modern financial software like PivotXL can greatly enhance incrementalism budgeting by automating data collection and analysis.
Conclusion
Now you know all about incremental budgeting—what it is, how to do it, and whether it fits your business best. Pulling your actuals into a model to begin your budgeting process can be challenging, but modern tools and software solutions can streamline this task while maintaining the integrity of your financial data. With a clear understanding of incremental budgeting, you can create a robust plan that supports cost control and strategic growth. Ultimately, incrementalism budgeting remains a powerful tool for managing consistent financial performance over time.
