Use It or Lose It: Is This the Best Way to Manage Budgets?

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OK, it's time to submit your annual budget for the next fiscal year. You work in an environment where if you did not spend all of your budget for the current fiscal year, then your budget for the next fiscal year will be reduced.

If this scenario describes your organization, then congratulations; you are a member of the 'Use It or Lose It Budgeting' club! This method of budgeting is formally known as 'Incremental Budgeting' (IB).

IB involves using the previous period's budget to set the base line for the next budget period.

IB has some positive features. First, it is easy to understand and implement; it allows one to add or subtract from the next budget based on the activity of the current budget. Second, it promotes stability across budget periods; to anticipate what one needs for the next budget period, you merely examine spending against the current budget. This is also known as the 'burn rate'. Third, it is customizable; you can implement this on a daily, weekly, monthly or annual basis. Fourth, it can be implemented independently across cost centers. Each cost center can use its own periodicity for monitoring spending.

However, IB has enough negative features to easily dwarf the positive features. First, IB does not work well with organizations that have massive shifts in their revenue stream. The assumption is that the next day/week/month/year will be the same as the current day/week/month/year. Second, it can stifle innovation. Nothing is budgeted to reward unplanned game-changing ideas. Third, it disincentivizes managers from making wise decisions regarding fiscal activities; the frugal manager who is able to save money for a given budget period, is punished by having his/her budget reduced by the amount saved. Fourth, this method creates a business risk because there is a rush to make bulk purchases of equipment that may be low in quality or simply useless.

There are plenty of horror stories of IB. One Washington Post article details how: (1) the Department of Veterans Affairs purchased $562,000 worth of artwork, (2) the Agriculture Department spent $144,000 on toner cartridges and (3) the Coast Guard spent $178,000 on cubicle furniture rehab. Why? Simply to ensure that they would not lose funding the next fiscal year. An article in the Chicago Policy Review stated that the State Department spent $1,000,000 on artwork made of granite blocks to ensure that its next budget would not get cut.

So returning to the title of this piece, is IB/'Use It or Lose It' the best way to manage budgets? For example, if you need some unbudgeted analytics software, do you want to hold your breath until a month before the end of the budget period to know if the funds are available? Do you want invest the time in researching software that may not be purchased? Or what about a class or a conference -- do you want to writhe in suspense as you wait to learn the decision regarding your request. And looking forward, do you want to just order new and possibly superfluous books, keyboard cleaning spray, clip on lights, etc. just to ensure that the funding stays in place? Do the Dilbert panels composed by Scott Adams mirror your own experiences?