Zero-Based Budgeting: A Comprehensive Guide

Zero-Based Budgeting: A Comprehensive Guide

5 mins read203 Views Comment
Chanchal
Chanchal Aggarwal
Senior Executive Content
Updated on May 23, 2024 17:59 IST

Zero-based budgeting entails building a budget from scratch, justifying every expense, rather than basing it on previous budgets. This approach encourages a critical examination of costs, promoting efficiency and cost-saving by ensuring that only necessary and justifiable expenses are included in the budget.

2023_03_What-is-Zero-Based-Budgeting-1.jpg

A budget is the organization’s playbook for the next year. Unlike the traditional budget, the zero-based budget begins from scratch, with an increment increase done on the previous year’s budget. It always starts from the beginning. Each expense must be reviewed at the commencement of the budgeting period.  

Zero-based Budgeting (ZBB) is a technique that has recently gained popularity. Unlike traditional budgeting methods, which base the budget on the previous year’s expenses, ZBB starts from scratch each year. In this blog post, we’ll explain zero-based Budgeting, how it works, and why it can be a game-changer for businesses of all sizes.

Must read: What is Accounting?

Table of Content

Explore Accounting Courses

What is Zero-Based Budgeting?

Zero-based Budgeting is a budgeting technique that requires all expenses to be justified from the ground up. This means that each department or program starts with a zero budget and must justify every expense they make. In other words, nothing is assumed or taken for granted. Every expense must be evaluated based on its contribution to the organization’s goals.

Learn All About Capital Budgeting
Learn All About Capital Budgeting
Learn about capital budgeting, different capital budgeting techniques, characteristics, limitations, and much more.

Difference Between Marginal Costing and Absorption Costing
Difference Between Marginal Costing and Absorption Costing
The main difference between marginal costing and absorption costing is that in marginal costing, variable cost is treated as product cost, and fixed cost is treated as period cost. On...read more

How Does Zero-Based Budgeting Work?

Zero-based Budgeting is a method that requires all expenses to be justified from the ground up. This means that each department or program starts with a zero budget and must justify every expense they make. There are no assumptions or suppositions made. Organizations must evaluate every expense in light of its contribution to their goals.

Why Can Zero-Based Budgeting Be a Game-Changer?

There are several reasons why this method can be a game-changer for businesses. Let’s understand.

Increased Accountability: With this, each expense must be justified based on its contribution to the organization’s goals. This creates a culture of accountability, where accountants evaluate every expense based on its value to the organization.

Better Resource Allocation: It allows businesses to allocate their resources more efficiently. By prioritizing expenses based on their contribution to the organization’s goals, businesses can focus on the expenses that will have the greatest impact.

Improved Cost Management: Businesses can identify and eliminate unnecessary expenses with this. This can lead to significant cost savings, which an individual can be reinvest in the organization.

Increased Flexibility: This method allows businesses to adapt quickly to changing circumstances. By evaluating yearly expenses, businesses can adjust their budget to reflect changes in their goals or external factors.

Improved communication: It involves a more collaborative and transparent process than traditional Budgeting. This can help improve department communication and ensure everyone is aligned with the organization’s goals.

Cost Volume Profit Analysis: Components and Benefits
Cost Volume Profit Analysis: Components and Benefits
Cost-Volume-Profit (CVP) Analysis is a fundamental financial analysis tool that explores the relationship between costs, sales volume, and profitability. It assists businesses in understanding how changes in costs and volume...read more

Difference between Standard Costing and Budgetary Control
Difference between Standard Costing and Budgetary Control
The primary difference between Standard Costing and Budgetary Control is their focus. Standard setting cost benchmarks and analyzing actual costs against these standards for cost control. Budgetary control revolves around...read more

Zero-Based Budgeting vs Traditional Budgeting

Zero-based Budgeting (ZBB) and traditional Budgeting are two different approaches businesses can use to allocate resources and manage expenses. While both techniques have their benefits, there are some key differences between them.

  Zero-Based Budgeting Traditional Budgeting
Meaning Zero-Based Budgeting requires all expenses to be justified from scratch each year, regardless of previous budget levels. Traditional budgeting adjusts for inflation, growth, and changing business conditions based on the previous year’s budget.
Assumption It evaluates every expense based on its contribution to the organization’s goals. It starts with the assumption that last year’s budget was correct and built on that.
Basis of Budget It starts with a zero budget and requires each expense to be justified from scratch. It is based on the previous year’s budget.
Focus It prioritizes expenses based on their contribution to the organization’s goals. It focuses on incremental changes and improvements.
Resource Allocation This method allocates resources based on each expense’s value to the organization. This method tends to allocate resources based on historical spending patterns.
Time-Frame It is done on a more frequent basis. It is usually done annually.
Process This method involves a bottom-up process where each department or program justifies its expenses individually. It involves a top-down process, where budget targets are set by senior management and then cascaded down to departments or programs. 

Overall, both traditional Budgeting and zero-based Budgeting have their benefits and drawbacks. Traditional Budgeting is simpler and quicker, while zero-based Budgeting is more resource-intensive but can lead to more efficient resource allocation—the two techniques depend on the organization’s goals, resources, and culture.

Highlights of the Union Budget 2023
Highlights of the Union Budget 2023
Union Budget of India is the annual budget of the country that is presented every year in the beginning of the month of February (mostly the 1st of February). This...read more
Difference between Standard Costing and Budgetary Control
Difference between Standard Costing and Budgetary Control
The primary difference between Standard Costing and Budgetary Control is their focus. Standard setting cost benchmarks and analyzing actual costs against these standards for cost control. Budgetary control revolves around...read more

Disadvantages of Zero-Based Budgeting

While ZBB can be a powerful tool for businesses, it’s important to recognize that this approach has potential disadvantages. Here are the various most common disadvantages.

Time-Consuming: It requires each expense to be justified from scratch, which can be time-consuming. This can be especially challenging for larger organizations with many departments or programs.

Resource-Intensive: Justifying each expense can require significant resources, including staff time and expertise. This can strain smaller organizations with limited resources.

Limited Historical Context: This method considers historical spending patterns, making it difficult to identify trends or anticipate future expenses.

Risk of Bias: It requires each expense to be justified based on its contribution to the organization’s goals. However, there is a risk of bias or subjective decision-making, leading to accurate or complete justifications.

Potential for Micromanagement: It can create a culture of micromanagement, as each expense is evaluated and justified individually. This can lead to a lack of trust and autonomy among employees.

Difficulty comparing budgets: Comparing budgets from year to year can be difficult, as each budget starts at zero. This can make it challenging to track progress or identify areas of improvement over time.

Conclusion

Zero-based Budgeting is a technique that requires every expense to be justified based on its contribution to the organization’s goals. Starting from scratch each year, businesses can allocate their resources more efficiently, identify unnecessary expenses, and adapt quickly to changing circumstances. While this approach can be more time-consuming than traditional budgeting methods, the benefits are significant.  It is a game-changer for businesses that want to increase accountability, improve resource allocation, and manage costs more effectively.

Top FAQs on Zero Based Budgeting

What is Zero-Based Budgeting (ZBB)?

Zero-Based Budgeting is a method where every expense must be justified for each new period, starting from a "zero base," rather than adjusting the previous budget.

How does Zero-Based Budgeting differ from traditional budgeting?

Traditional budgeting adjusts previous budgets by a percentage, while ZBB requires each expense to be reviewed and justified from scratch.

What are the main benefits of Zero-Based Budgeting?

Benefits include more efficient allocation of resources, cost savings, improved financial discipline, and enhanced strategic alignment of expenditures.

What are the key steps in implementing Zero-Based Budgeting?

Steps include defining decision units, evaluating and ranking activities, allocating resources based on necessity and benefits, and continuous monitoring and adjustments.

How does Zero-Based Budgeting improve cost management?

By requiring justification for all expenses, ZBB eliminates unnecessary spending and prioritizes activities that add value, leading to better cost management.

About the Author
author-image
Chanchal Aggarwal
Senior Executive Content

Chanchal is a creative and enthusiastic content creator who enjoys writing research-driven, audience-specific and engaging content. Her curiosity for learning and exploring makes her a suitable writer for a variety ... Read Full Bio