Zero-Based Budgeting
This article What is Zero-Based Budgeting? is about high-level strategic goals to be
implemented into the budgeting process by tying them to specific functional areas of an
organization, where costs can be first grouped and then measured against previous results and
current expectations.
Zero-Based Budgeting is used in monitoring of MBO (Management by Objective).
Definition of Zero-Based Budgeting
Zero-Based Budgeting (ZBB) is a method of budgeting in which all expenses must be justified
for each new period, regardless of whether each budget is higher or lower than the previous
period.
Or, ZBB in management accounting involves preparing the budget from the scratch with a zero-
base and every function within an organization is analysed for its needs and costs.
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What is Zero-based Budgeting?
What is Zero-Based Budgeting?
Zero-Based Budgeting is a method of budgeting, whereby all the expanses for the new period
are calculated based on actual expenses that are to be incurred and not on the differential basis
which involves, just changing the expense incurred taking into account change in operational
activity.
In this method, every activity needs to be justified, analyzed the costs of every function within
an organization and allocating funds accordingly, regardless of how much money has previously
been budgeted to any given line item. ZBB can be translated into cost-saving that fund future
strategic initiatives and drive growth.
Steps of Zero Based Budgeting
There are some steps of Zero-based budgeting :
1. Identifying the units that need a justification for every line item of expenditure in the
proposed budget.
2. Preparing Decision Packages (Decision package comprises the explanation of the
activity, money involved, need for the item, the benefit arising from implementing the
proposal, etc.) Each decision package is an identifiable and separate activity. These
decision packages are connected with the objectives of the company.
3. Rank the decision packages. This ranking is done based on a cost-benefit analysis.
4. Setting the budgeted priorities on the basis of the above findings to ensure maximum
results.
Example of Zero-Based Budgeting (ZBB)
Let us take an example of the manufacturing department of a company that spent $20 million
last year. The problem is to budget the expanse for the current year. So, in this current year, it
can either increase or decrease the requirement to $22 million or $18 million, respectively. ZBB
involves calculating all the expanses of the department and justifying each one of them. This
reflects the actual demand, which may be $21 million.
Zero-based Budgeting Advantages and Disadvantages
Advantages of Zero Based Budgeting
Efficiency:
ZBB helps in efficient allocation of department-wise resources as it doesn’t notice at the
historical numbers but notices at the actual numbers.
Accuracy:
Unlike the regular methods of budgeting that involves making some arbitrary changes to the
previous year’s budget, Zero-based budgeting makes every department recheck each and every
item of the cash flow and compute their operation costs. It helps in cost reduction as it gives a
clear picture of costs, unlike the desired performance.
Budget Expansion:
Since every line item is to be confirmed, Zero-based budget overcomes the weakness of
incremental budgeting of budget expansion.
Reduce Waste:
It can remove excessive spending by re-examining possible unnecessary amounts.
Promotes Optimization in Business Process Management:
Streamlining spend and focusing on those items that directly make profit for your business
through more value, greater efficiency, cost reductions etc. supports continuous improvement
over time.
Improvement of Coordination and Communication:
Zero-based budgeting also improves coordination and communication within the department
and motivates the employees by involving them in decision making.
Zero-Based Budgeting Disadvantages
Expensive and Complex:
Unlike traditional budgeting system, zero-based budgeting can be very costly, time-consuming,
and complicated to execute. It required extra training, new and better software along with the
fact that each budget it built from scratch rather than relying on the data from last year can add
significant expanse when making the change.
Lack of Expertise:
Analyzing every line item and every cost is a difficult task and requires extra training and
managers.
It’s Disruptive:
Making the change to zero-based budgeting can result emotionally and intellectually taxing for
some people. Employees may find it difficult to make the switch to ZBB.
A significant change in the budget can also threaten the entire operation.
Zero-Based Budgeting Vs. Traditional Budgeting
Zero-Based budgeting and traditional budgeting are the two frequently used budgeting
techniques. These techniques help the companies to allocate investment to different departments.
These methods of budgeting vary from each other in many aspects that are Justification of data,
the base of budgeting, flexibility in the modification of budget components, the time required,
allocation of resources, ease of preparation and training, etc.
Both methods of budgeting have their own advantages and disadvantages. So you need to choose
the preferred method, depending on what they desire to get through the budgeting process.
Zero-Based Budgeting Traditional Budgeting
In traditional budgeting, only the items
In zero-based budgeting, taking the base as zero as which are over and above the last year’s
if there is no past or historical data. Here all the budget need to be justified. That means
elements in the cash flow need to be justified. only incremental changes require an
explanation, not everything items.
Zero-based budgeting is done considering the base Traditional budgeting uses the previous
as zero. For every financial period, they prepared a year’s budget as a standard to make the
fresh budget from the scratch. current year’s budget.
One of the biggest issues with zero-based In traditional budgeting, since changes are
budgeting is that it is a time-consuming process as done in the previous year’s budget to meet
they prepared the budget from the start. Any the needs of the current period, half the
project, before being added to the budget, goes task is already done before the budget
through a lot of comparisons and approvals, which process starts and only some incremental
leads to spending enormous time on each project. changes are required.
Traditional budgeting is done regarding no
With zero-based budgeting, the management can priority to vital activities of the business
focus on priority decisions only. and last year’s budget is simply adjusted
considering the inflation factor.
Managers need special skills and knowledge to
prepare zero-based budgets. Only an experienced Traditional budgets are quite easier to
and well-trained professional can prepare such prepare, as they do not involve complex
budgets. Thus, preparing zero-based budgets is a calculations.
complex task.
Difference between Zero-based budgeting and Traditional budgeting.
