Zero Based Budgeting
ZBB (zero based budgeting) can be explained as a rigorous process of budgeting and requires every expense to be justified even if it has been occurring for several years. It involves the re-evaluation of every factor of the cash flow statement and justifying every expense incurred by the department.
Therefore, ZBB is a method of budgeting in which all the expenses of a particular new period is calculated on the basis of actual expenses that are expected to incur rather than on incremental basis which includes increased expenses that incurred in previous years at a fixed rate. Within this budgeting method, every activity should be justified and every cost that generates revenue for the company should be explained.
ZBB (zero based budgeting) is a contrasting method to that of traditional budgeting practices which aim at the incremental change from current expenses and budget.it assumes that no balance will be carried forward or that no expenses are pre-committed. Literally speaking, zero-based budgeting is a method with zero prior basis and focus on identifying a task and then recording expenses irrespective of the current structure of expenditure.
Steps Involved In Zero-Based Budgeting
- Identifying a task
- Finding means to accomplish the task.
- Evaluating all available solutions and evaluating sources of funds.
- Setting priorities and budgeting numbers.
How ZBB (Zero Based Budgeting) Is Different From Traditional Budgeting Practices
Bases for Budgeting
Zero-based budgeting is a budgeting practice in which the current year’s budget is prepared with zero bases or from scratch. Traditional or incremental budgeting method requires preparing current year’s budget by making some changes in the previous year’s budget. The changes take place in the form of adding in or reducing expenses to the previous year’s budget.
In zero-based budgeting, budget preparation takes place by allocating maximum resources to activities that offer maximum benefit to the business. On the other side, incremental budgeting is undertaken without giving any priority to activities that are crucial for business and the previous year’s budget is adjusted by considering inflation rate.
As ZBB (zero based budgeting) is prepared from the scratch, any allocation of resources to activities will be based upon cost benefit analysis and risk reward ratio. In this way, any wasteful expense is avoided. In case of incremental budgeting, wasteful expenses are a part of the budget. The inefficiencies that are present in the processes are ignored and only the increment in cost becomes a part of the budget.
Through zero-based budgeting, innovation can be promoted in the business. Since the budgets are prepared from the scratch, it gives business leaders new ideas to innovate for reducing their operational cost so that the allocation of resources can be justified. Traditional budgeting methods lead companies to have a conservative thought. Because the budgets are nearly same every year, chances of innovating in the business are very low. Zero-based budgeting has a very dynamic nature.
Business managers require having special knowledge and skills for preparing zero-based budgets. A well-qualified and professional person has the ability to prepare this budget. Conversely, traditional budgeting methods are easy and can be prepared easily by managers. They do not have the requirement of any special training or knowledge and any department can make the budget.
Advantages of ZBB (zero based budgeting)
- Efficiency: Zero-based budgeting allows for efficient allocation of resources as historical numbers are ignored and actual figures are considered.
- Accuracy: As against regular methods which bring in minor changes in previous year’s budget, ZBBB calls for every department to consider every item in the cash flow statement and then compute its operational costs. This also gives an opportunity for cost reduction and provides an understanding of incurred costs as against desired performance.
- Reduction in wasteful activities: ZBB (zero based budgeting) looks for identifying opportunities and a more cost-effective manner of making things done by eliminating every unproductive or wasteful activity.
- Budget inflation: As every item requires justification zero-based budgeting overcomes the weakness of budget inflation in incremental budgeting.