There are many different ways a business might prepare a budget. Here we compare two common approaches.
The incremental budget starts with an existing set of figures (actual results, or the budget for the current period) and then adds or deducts amounts based on the expectations for the future. The incremental adjustments take into account things like inflation, and planned increases in sales prices, sales volumes, and costs.
Incremental budgeting is useful because it is a relatively simple approach, and therefore easier and quicker to prepare than using other budgeting methods. It is also simple to understand.
There are however some weaknesses in the incremental budgeting approach. The chief problem is that it can lead to waste and inefficiency, because it does not encourage management to question or challenge whether the budgeted activities - and costs - are actually needed. Put simply, just because the organisation spent £x last year, it does not always follow that it should spend £x plus x% this year.
Activity-based budgeting (ABB) is a more rigorous budgeting approach (compared to incremental budgeting) because it requires a careful examination of the different activities that the organisation undertakes, and the costs associated with each those activities.
ABB encourages management to consider more closely the relationship between activities and costs, and to challenge and question how the organisation can deliver its aims cost effectively.
Compared to incremental budgeting, ABB is a more sophisticated approach which can allow for more control over the budgeting process.
The drawback is that ABB is more expensive to implement and maintain, compared to traditional budgeting techniques.
If you would like to discuss your business budgeting approach with us, contact us today.