Zero Based Budgeting: Meaning, Definition,Process, Advantages

  • Post last modified:3 March 2021
  • Reading time:12 mins read
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What is Zero-Based Budgeting?

Zero Base budgeting refers to a ‘nil‐budget’ as the starting point.It starts with a presumption that the budget for the next period is ‘zero’ until the demand for a function, process, or project is not justified for single penny. The assumption is that without such justification, no expenditure will be allowed. In effect, each manager or functional head is required to carry out cost‐benefit analysis of each of the activities, etc. under his control and for which he is responsible.

The method of ZBB suggests that the business should not only make decision about the proposed new programmes but it should also, regularly, review the suitability of the existing programmes. This approach of preparing a budget is called incremental budgeting since the budget process is concerned mainly with the increases or changes in operations that are likely to occur during the budget period.

Definition of Zero Budgeting

“Zero Based Bugdting define as a management tool, which provides a systematic method for evaluating all operations and programmes, current or new, allows for budget reductions and expansions in a rational manner and allows re‐allocation of sources from low to high priority programmes.” ‐ David Lieninger

Process of Zero Based Budgeting

These are main steps of zero based budgeting:

  1. Determination of the objective
  2. Degree at the ZBB is to be introduced
  3. Growth of Decision units
  4. Growth of Decision packages
  5. Assessment and Grading of decision packages
  6. Allotment of money through Budgets

Determination of the objective

This is an initial step for determining the objective to introduce ZBB. It may result into the decreased cost in personnel overheads ordebunk the projects which do not fit in the business structure or which are not likely to help accomplish the business objectives.

Degree at the ZBB is to be introduced

It is not possible every time to evaluate every activity of the whole business. After studying the business structure, the management can decide whether ZBB is to be introduced in all areas of business activities or only in a few selected areas on the trial basis.

Growth of Decision units

Decision units submit their data as to which cost benefit analysis should be done in order to arrive at a decision that helps them decide to continue or abandon. It could be a functional department, a programme, a product‐line or a sub‐line. Here the decision unitsexist independent of all the other units so that when the cost analysis turns unfavourable that particular unit could be closed down.

Growth of Decision packages

Decision units are to be identified for preparing data relating to the proposals to be included in the budget,concerned manager analyzes the activities of his or her own decision units. His job is to consider possible different ways to fulfill objectives. The size of the business unit and the volume of goods it deals with determine the number of decision units and packages.

The decision package has to contain all the information which helps the management in deciding whether the information is necessary for the business, what would be the estimated costs and benefits expected from it.

Assessment and Grading of decision packages

These packages invented and formulated are submitted to the next level of responsibility within the organization for ranking purposes. Ranking basically decides as to whether or not to include the proposals in the budget. The management ranks the different decision packages in the order from decreasing benefit or importance to the organization.

Preliminary ranking is done by the unit manager himself and for the further review it is sent to the superior officers who consider overall objectives of the organization.

Allotment of money through Budgets

It is the last step engaged in the Zero Based Budgeting process. According to the cost benefit analysis and availability of the funds management has ranks and thereby a cut‐off point is established. Keeping in view reasonable standards, the approved designed packages are accepted and others are rejected. The funds are then allotted to different decision units and budgets relating to each unit are prepared.

Advantages of Zero Based Budgeting

These are some imprtant advantages of Zero based budgeting given below:

  1. Zero base budgeting examines all existing and new programmes and activities. It also makes the managers analyse their functions, establish priorities and rank them. This exercise helps in identifying inefficient or obsolete functions within the area of responsibility. In this way resources are allocated from low priority programmes to high priority programmes.

  2. This system facilitates identification of duplication of efforts among organisational units. Such inefficient activities are eliminated and some other activities are merged.

  3. All expenditures, under this system are critically reviewed and justified and all operational activities are evaluated in greater detail in terms of their cost effectiveness and cost-benefits. This requires managers to find alternative ways of performing their activities which may result in more efficient procedures.

  4. ZBB promotes the tendency to initiate studies and improvements during the period of operation as the persons at the helm of affairs know that the process would be exercised next year and their knowledge and training would enhance efficiency and cost-effectiveness.

  5. Zero Based Budgeting provides for quick budget adjustments during the year. If revenue falls short in this process, it offers the capability to quickly and rationally modify goals and expectations to correspond to a realistic and affordable plan of operations.

  6. Zero Based Budgeting ensures greater participation of personnel in formulation and ranking processes. This helps in promoting level of job satisfaction and thus resulting in better control and operational efficiency in the organisation.

  7. Zero base budgeting is a flexible tool that can be applied on a selective basis. It does not have to be applied throughout the entire organisation or even in all the service departments. Keeping in view the limitations of time, money and persons available to instal, operate and monitor it the management thus can select priority areas to which zero base budgeting may be applied.

The benefits of Zero Based Budgeting thus can be summed up as follows: –

  • It eliminates redundant activities and those which are being duplicated.
  • It identifies low and high priority activities for resource deployment.
  • It justifies budget requests on cost-benefit and cost-effectiveness basis.
  • It allocates scarce resources rationally.
  • It sharpens and quantifies objectives and formulates alternative methods of operations.
  • It promotes involvement of line managers in budget formulation.

Disadvantages of Zero Based Budgeting

These are some disadvantages of Zero based budgeting given below:

  1. ZBB is time consuming and is a more complicated process than the conventional budgeting. It requires more staff, a great deal of time and effort as compared to conventional budgeting system. For managers at all levels to understand the system thoroughly there is need for proper communication system.

  2. It also requires high volume of paper work,hence sometimes it becomes a tedious job. Each decision unit is supposed to prepare decision packages and give proper justification. In government departments where there are thousands of programmes and activities, the number of decision packages may run into several thousand. This is bound to create handling problems and confusion.

  3. In ZBB there is a danger of emphasizing short‐term benefits at the expenses of long-term ones.

  4. This is not a new method for evaluating various alternatives, and cost‐benefit analysis.

  5. The psychological effects can also not be ignored. It holds out high hopes as a modern technique, claiming to raise the profitability and efficiency of the business.

  6. Zero base budgeting decision and the process fixing priorities become a political nightmare. Conflict may arise on ranking as managers have a tendency to assign a higher priority, to their own projects.

  7. The ranking of decision packages, particularly when the number of such packages is large, creates a big problem. The ranking may become an unwieldy process.

Problems of Zero Based Budgeting can be summed up as:

  • It challenges the past practices, performance, attitudes, of people.
  • It requires more time and effort.
  • Detailed costs and necessary information for decision packages often are not made available.
  • It increases paper work to unmanageable proportions.
  • Ranking a large number of decision packages becomes an unwieldy process.
  • Identifying various levels of funding, particularly the minimum level is a difficult task.

Zero Based Budgeting vs. Traditional Budgeting

Zero based budgeting is superior to traditional budgeting in the following manner:

  • It provides a systematic approach for evaluation of different activities.

  • It ensures that the function undertaken are critical for the achievement of the objectives.

  • It provides an opportunity for management to allocate resources to various activities after a thorough – cost-benefit analysis.

  • It helps in the identification of wasteful expenditure and then their elimination. If facilitates the close linkage of departmental budgets with corporate objectives.

  • It helps in the introduction of a system of Management by Objectives.

Difference between Traditional Budgeting and Zero- Based Budgeting

Following are the points ofdifference between traditional budgeting and zero- basedbudgeting:

  1. A Traditional Budget is function-oriented but a Zero-Base Budget is programme or project- oriented.

  2. In case of Traditional Budgeting, the existing programmes or projects are self-perpetuating for which no re-justification is required. Justification is needed only for new programmes or projects. Zero-Base Budgeting presenting that all programmes for projects whether on-going or new, must be justified on the ground that they all compete for the same scarce resources.

  3. Traditional Budgeting views critically only the cost increases whereas the Zero-Base Budgeting critically examines existing levels of expenditure, as the level of expenditure approved for the last budget is not necessarily acceptable for the current budget.

  4. Traditional Budgeting is input-oriented i.e. resources required; Zero-Base Budgeting is output- oriented i.e. results achieved.

Thus, the Traditional Budgeting techniques may be quite meaningless in the present context when management must review to better utilisation of scarce resources or to improve performance.

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