When you’re running a business, establishing a budget and keeping close tabs on your financial standing is essential—it helps put your business on solid footing and sets you up for future growth. Adhering to a budget in business will ensure your ability to keep things running, help you plan for unexpected expenses, and help save money for the future.

While there’s no shortage of options for you to consider when deciding exactly how you want to go about budgeting for your business, one widely adopted method among entrepreneurs is called incremental budgeting. If you’re trying to find an approach to budgeting that will work for you, you’ve come to the right place. In this article, we’ll cover everything you need to know about incremental budgeting to determine whether it’s the right method for you.

Incremental budgeting explained

So, what is incremental budgeting? An incremental budget takes the current period’s revenue into account each month and uses that as the basis on which all other budgetary line items are defined, adjusting each by (as the name suggests) incremental amounts.

You’ll start by collecting numbers from a previous period, be that a month, quarter, or year. Break out individual expenses into their appropriate budgetary categories—for example, salary, rent/mortgage, utilities, material costs, equipment repair/maintenance, structural repair/maintenance, marketing, insurance, etc.—so you can quickly understand your spending habits. Then, use that data to project your future budget by adjusting each category up or down, depending on your expectations for growth or redirection.

Incremental budgeting example

To get a clearer sense of how this works in practice, let’s consider salary, as it’s typically the largest business expense you’ll have. If you’re trying to determine the adjustment for salary in a future period, you’ll need to know what you paid your staff in the previous period and by how much that expense will be increasing after performance reviews are conducted and raises are determined. You’ll also need to know how many more staff members you’ll be bringing on as your business grows or changes.

If you spent $100,000 in the previous year on four staff members’ salaries, intend to give all existing employees a 10% raise, and plan to grow your business by bringing on three new employees at a salary of $25,000 each, you’ll use the following formula to scale up this budget line item:

Previous years’ salary + % of salary increase for raises + new employee salaries

In this specific example, that would translate to $100,000 + $10,000 + $75,000, and your new budget for staff salary would be scaled up to $185,000. Now you have a projected budget for this category and know what data points need to be accounted for when scaling the budget next time around.

In order to further develop your understanding of this budgeting model and help you decide if it’s right for your business, let’s explore some of its pros and cons.

Benefits of incremental budgeting

There are many reasons why this method of budgeting has been so widely used, and the specific perks vary based on the kind of business you run and the industry in which you operate. However, there are a few things you’ll see in this method no matter what kind of business you’re running. Here are our top three pros:

  1. It’s simple: Incremental budgeting is by far one of the simplest methods available to you. Rather than painstakingly running complicated calculations every period in order to get your business ready for the next one, incremental budgeting allows you to save time and effort by using the knowledge you have about your company to quickly adjust your budget where you need to.
  2. It creates stability: Because you’re building future budgets off of ones you’ve already used, the budget stays pretty consistent from one period to the next. And if you’re a business that has projects running over the course of several years, this also helps keep funding stable year after year.
  3. Minimizes competition: Since all areas of the budget are generally increased uniformly, this approach cuts back on potential departmental rivalry—no one feels the need to compete for their fair share.

This approach differs from more traditional, zero-based budgeting approaches in the sense that, rather than deciding how much to allot for each line item, you’re using previous budgets, your current revenue, and inflation to dictate budgetary adjustments.

While some criticize this method by suggesting that not enough thought and consideration are put into it, that is simply not the case. Budgets of any kind require care and consideration in order to be effective. One characteristic of incremental budgeting, however, is that you spend less time each month on the justification of each line item. Because you’ve already done this in creating your first budget, it’s assumed that every item included remains necessary unless a complete overhaul is conducted and an item is removed.

Drawbacks of incremental budgeting

While the benefits speak for themselves, there are naturally some drawbacks to consider as well. Here are three to weigh into your evaluation of the budgetary methods available to you:

  1. May promote overspending: While it reduces interdepartmental conflict about who has more money, incremental budgeting sometimes leads to overspending when departments receive and spend more money than might be deemed essential.
  2. Could reduce innovation: Another downside of incremental budgeting is that, because the process is so easy to replicate, it can blind you to other approaches to budgeting that may benefit your business even more.
  3. Doesn’t take external factors into consideration: Since the budget assumes constancy and stability, some businesses have struggled to plan for and respond to unforeseen occurrences, resulting in financial setbacks.

In any budgeting method, there are blind spots you need to be aware of and compensate for—build this into your adjustment plan, and you’ll avoid a serious setback.

Is incremental budgeting right for you?

Incremental budgeting is a popular approach—it’s easy to understand, and it’s easy to implement. This makes it attractive to many business owners who are just starting out. However, newer businesses are likely to experience a lot of volatility. When the element of predictability is largely absent, it makes an incremental budget much more difficult to successfully implement.

In contrast, established businesses have more clearly defined costs and a degree of stability and predictability smaller and newer businesses lack. Because their costs aren’t as susceptible to unanticipated fluctuation, it makes it easier to use an incremental budget with confidence that it can help achieve growth.

That said, no two businesses are alike, no matter how similar they may seem on paper. Incremental budgeting may turn out to be an unexpectedly good (or poor) option for your business—a conversation with your banker or financial adviser can provide much-needed clarity and help ensure you’re taking your business in a smart financial direction.

Once you’ve been in business for a year or two, the process of creating and implementing an incremental budget becomes easier. You’ll be able to make use of the previous year’s budget month by month to account for seasonal revenue fluctuations and adjust as needed for increases in your operating expenses. While inflation is typically the basis for increases, some businesses choose to incorporate other factors when making their adjustments. Keep this in mind when planning your own incremental budget.

Bank with the best

A key aspect of any budget is making sure you’re working with professionals who are equipped to help you save and plan for the future you envision for your business. North One was created with small business owners in mind. Our small business banking tools and products are made to ease the stress of any routine business activities—including finding the information needed to establish an incremental budget and save for the unexpected. Visit us online to learn more and get started on your journey to financial health.