Incremental Budgeting

Incremental budgeting is the most common way organizations set budgets. Rather than building each budget from scratch, managers start with last year's budget or actual spending and adjust it for expected changes, such as inflation, growth targets, new projects or planned savings. A department that spent $10 million last year might receive $10.3 million this year, a 3 percent increase, with adjustments for specific known changes.

The approach is popular because it is quick, simple and stable. It also has well-known weaknesses: it tends to preserve existing spending patterns, rewards spending the full budget and does little to challenge whether costs are still necessary. For IT financial management, understanding these strengths and weaknesses helps leaders decide where incremental budgeting works well and where a more rigorous approach is needed.

Definition of Incremental Budgeting

Incremental budgeting is a method of preparing budgets by taking the prior period's figures as a starting point and making incremental changes. The changes may be across-the-board percentages, such as a 2 percent increase for inflation, or specific adjustments for known events, such as a new contract or a retired system.

The underlying assumption is that the prior period's spending was reasonable and that only the changes need to be justified. That assumption is often sound for a year or two, but becomes less reliable the longer the base goes without review. This contrasts with zero-based budgeting, in which every cost must be justified from zero each period.

How It Works

Budget owners receive their prior-year budget or actuals along with guidance from finance, such as an overall growth or reduction target. They then propose adjustments, explaining the reasons for significant changes.

Finance consolidates the proposals from every department, compares the total with the organization's financial targets and negotiates adjustments where needed. The final budget is usually close to the prior year, with targeted changes. In many organizations the whole cycle takes a few weeks, compared with several months for a full zero-based exercise.

Incremental and Zero-Based Budgeting

Zero-based budgeting requires each cost to be justified from scratch, as if the organization were starting fresh. It can uncover unnecessary spending but takes significant time and effort, especially for large, complex budgets.

Many organizations use a hybrid. They apply incremental budgeting to stable costs and use zero-based reviews for selected areas, such as the largest cost categories or areas where spending has grown rapidly, rotating these reviews over several years. This keeps the effort manageable while ensuring that no area of spending goes unexamined for too long.

Importance of Incremental Budgeting in IT Financial Management

Incremental budgeting is widely used for IT budgets, and its effects on technology spending can be significant over time. Understanding them helps IT finance teams decide where to apply more scrutiny.

The approach has clear benefits, but its weaknesses can accumulate if they are not managed.

Benefits of Incremental Budgeting

Incremental budgeting is efficient. It requires far less effort than building every budget from scratch, which matters when IT teams also need to run services and deliver projects. It also provides stability, since teams can plan with reasonable confidence that their funding will continue.

For stable, well-understood costs, such as long-term contracts, depreciation and core staffing, incremental adjustments are usually accurate enough. Rebuilding these costs from zero each year adds little value. Incremental budgeting also makes year-over-year comparisons simple, since each line can be compared directly with its prior-year equivalent through budget variance reporting.

Weaknesses and Risks

Because the starting point is last year's spending, incremental budgeting tends to lock in existing costs, including those that are no longer needed. Unused licenses, redundant applications and outdated contracts can persist for years. The longer a budget is set incrementally, the more of these costs tend to accumulate in the base.

It can also encourage managers to spend their full budget, since unspent funds may be removed the following year. And it can make it harder to shift investment from running existing systems toward new priorities, since each area's base is treated as a given, reinforcing a high share of run spending in the run, grow, transform mix.