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.
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.
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 :
- Identification of a specific task.
- Finding ways of accomplishing the task.
- Evaluating these features and also evaluating alternatives for the sources of fund.
- Setting the budgeted priorities and numbers.
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 maybe $21 million.
Zero-based Budgeting Advantages and Disadvantages
Advantages of Zero Based Budgeting
ZBB helps in efficient allocation of department-wise resources as it doesn’t notice at the historical numbers but notices at the actual numbers.
Unlike the regular methods of budgeting that involve in 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.
Since every line item is to be confirmed, Zero-based budget overcomes the weakness of incremental budgeting of budget expansion.
It can remove superfluous 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.
Making 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 whole operation.