Rational & Incremental Budgeting

by Dennis Hartman

Investors have many reasons to be interested in budgeting, whether it applies to the way they manage their personal finances or how the companies they invest in approach the budgeting process. There are many different ways for businesses to handle budgeting; the rational and incremental models are two very different options.

Rational Budgeting Explained

Rational budgeting is a broad term that refers to complex, fact-based budget decision making. A rational budgeting process takes numerous factors into account, including recent performance, trends in the market, plans for new products and the cost of borrowing money. Rational budgeting keeps the possibility of making cuts and restructuring the allocation of resources within an organization open. Business leaders go through several stages of meetings and debates, soliciting feedback from the individuals impacted by budget changes, before making decisions they feel are rational and good for business.

Incremental Budgeting Definition

Incremental budgeting is an alternative to a rational budget model. It relies on past budget data to form the basis for a new budget, with incremental additions to each budget category. Incremental budgeting assumes that past budgets allocate resources appropriately. It is among the simplest budget models since it uses the most recent budget as a guide and requires few complex decisions or input from multiple sources. However, incremental budgets are inflexible and difficult to change without introducing elements from another budgeting model.

Key Differences

The biggest difference between rational and incremental budgeting is the relative degree of complexity. Rational budgeting is a longer, more expensive process. However, it gives businesses more options when it comes to operating in multiple areas with limited financial resources. Incremental budgets are appropriate when little has changed since the last budget and there is additional money available to spend. New business goals, periods of financial hardship and innovative strategies are difficult to accommodate using an incremental budget model.

Impact on Business

The approach a business takes to budgeting can have a significant impact on its performance. Large, dynamic companies need to employ rational budgeting to take on new challenges and retain the flexibility necessary to take advantage of investment and growth opportunities. Rational budgeting can create costly delays when the debate between leaders moves from a rational discussion to a protracted competition for resources. For small businesses, incremental budgeting can save valuable time and money, setting up growth and a transition to a more complex budget model in the future.

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