Introduction of Zero Based Budgeting
Zero-based budgeting (ZBB) is a way of budgeting in which the budget is prepared in alignment with the organization’s strategies and goals. In ZBB the exercise starts from zero base (i.e.) all the elements of budgeting must be justified for every period of budgeting. It is basically made from scratch. A proper analysis needs to be done in fixing the budget value for every element like expense, cost, revenue, etc. for every year in Zero based budgeting. This budget is not like the traditional budgeting where the current budget is drawn from the previous period budget (i.e.) increase or decrease from the previous budget. (E.g.) In the current budget, 2% increase is considered in Administrative expenses from the previous budget.
ZBB is a time-consuming process as it involves a bigger process than the traditional cost-based budgeting. It drives the budget right from identifying the cost drivers, understanding and analyzing the previous year expenses and framing the value for recurring expenses, the justification for the new expenses, etc. In this method of budgeting, Cost optimization is possible as it starts from zero base instead of allocating an increase and decrease from the previous budgets.
In ZBB the funds are allocated to expenses according to the necessities, and requirements which drive business efficiency and performance. It prioritizes the justified expenses in budgeting rather than following the prior period budgeting trends. It is more of a strategic budget as it allocates the fund after complete analysis and reasoning of expenses. Detailed documentation and explanation are required for approval of the budget by the managerial personnel. ZBB brings discipline in the organization system in terms of spending and management which in turn leads to improved tracking and performance.
Steps in Zero Based Budgeting
The following are the steps in zero based budgeting are:
- Start from scratch (ZERO BASE).
- Identification of business target and requirements in terms of budgeting.
- Forming the route map and methods to accomplish the target along with proper justification for all components of the budget.
- Assessing the methods identified and to look for alternative methods to achieve the business targets. Standardize the process and setting up goals.
- Finalizing the budget numbers and roll out the budget plan and make sure it is clearly communicated to the respective functions.
Examples of Zero Based Budgeting
Zen Corp is the manufacturers of various car models. A major part of the car making is procured externally and the price of the same is on increasing trend year on year. Considering the zero-based budgeting model the company looks out for other alternatives for that major part like whether the company can afford to manufacture that major part on its own, does it have all the facilities, and also does the cost benefit analysis, thus in turn starts the estimation from scratch and finally arrive at the conclusion.
X space Inc. is a book selling company that is growing in the e-commerce space which previously had traditional outlets for selling the books. In the current year it has completely migrated to the e-commerce business. Now the company is planning to do ZBB as there is a complete shift in the way of operations. So, some key expenses they look into is renting expense, advertisement cost, staff cost, etc.
- Rent expense in prior period is $1,000 per month per outlet. They had totally 10 outlets in the city which comes to $10,000/ month. Now with the present set up they hardly require 2 offices set up for which they used two of their outlets. So, there is a cost savings to the extent of $8,000 per month.
- On the other end, the e-commerce business is challenging with a lot of emerging players. So, they decided to spend a good amount on advertisement in order to attract customers. In the previous period, they had spent only $10,000 totally for the advertisement in that year, but now considering the situation they have increased it to $50,000.
As mentioned above, ZBB looks into every element of budgeting and starts from scratch in order to find the right amount for the right expense without the influence of prior period budgets.
ZBB is an accurate method of budgeting as the budget is made from zero base with proper analysis. Each element of cost in budgeting is considered after collecting the right data.
- It is made based on the present needs and requirements instead of drawings no’s from the previous period. It is an efficient way to do budgeting and proper targets can also be set.
- It involves analyzing the previous period expenditure and takes into consideration the current requirements, so it helps to reduce the unwanted expenses. It leads to cost optimization and looks for possible savings.
- This budgeting requires collective efforts from all the teams, and departments in the organization, so, it helps in better co-ordination and transparency in the system.
- In ZBB all elements of the budget must be accepted, and it is unlike the old-style of incremental budgeting.
- Costs are justified and funds are allocated in line with the targets set. All allocations are done by activities and functions of performance.
- The orientation of cost allocation and expenses with respect to the organization’s goals, vision, and mission.
- ZBB is a time-consuming process. It takes a lot of time and efforts of staff.
- To prepare ZBB additional staffs may be required which in turn increases the cost for the organization. May not be comfortable for small sized firms with limited funding.
- The purpose of ZBB can be defeated if the results are uncertain.
- It is tough to justify all the expenses for considering the same in budgeting. Sometimes few expenses cannot be justified but still they play an important role for the prospects of the business. (E.g.) Advertisement expenses.
- To prepare ZBB proper training needs to be given to staff and to the managerial person as it requires an understanding of the activities performed and cost structure associated. It again comes with some cost and time.
Zero-based budgeting tries to arrive at the right expenses required to be incurred by the organization based on needs and requirements.ZBB can bring cost optimization, and it is bringing significance to the budgeting exercise. It helps in setting up right targets which can lead to improved business performance and operating efficiency. Though ZBB is a time-consuming exercise it is the most right and appropriate way of budget preparation. It also brings accountability and brings a sense of ownership in the system across all functional teams.
In ZBB all budget amounts need to be justified and it needs to be approved. The purpose of ZBB is to look out for opportunities and improve efficiency in budgeting and to reduce unnecessary expenses and costs. It is the concept of right spending for the right activities. It in turn leads to better utilization of the organization’s funds to the important activities which could bring desired results to the organization. It is a forward-looking way of budgeting.
This is a guide to Zero Based Budgeting. Here we also discuss the introduction and steps in zero based budgeting along with advantages and disadvantages. You may also have a look at the following articles to learn more –