This budget aims to evaluate and justify the costs and activities each year. ZBB, also known as zero-based or Zero based Budgeting (ZBB), is a different method of Budgeting that utilizes zero as the base. This method requires that they begin budgeting at zero every year. Additionally, it requires justification of every cost mentioned within the budget.
Zero-base budgets can use to aid in planning and making decisions. This reverses the technique uses in traditional Budgeting. The late Mr. Peter A. Pyhrr was the one who implemented this method at Texas Instruments in 1970. Also, the system is referred to as the “Father of zero-base budgeting.”
Definition of Zero Based Budgeting
In the words of David Heminger, “ZBB is an instrument for management that provides an organized method of monitoring all activities and programs whether new or existing. It allows cuts and increases in budgets that are done sensibly and permits re-allocation of funds from lower to high Priority Programs.”
As per ICMA, “ZBB is a method of Budgeting that requires all activities are evaluated every time the budget is established. The specific levels of each activity are analyzed, and a mix is selected to match the funds available”.
Powerful Characteristics of Zero Based Budgeting
Here are the most important aspects of budgeting zero-based:
- Zero-Based Budgeting requires the justification of every action mentioned in the proposed budget. It doesn’t allow any references to be made to previous decisions.
- Tools for making decisions useful to determine the activities that includes in the budgeting process.
- The tools useful to make decisions are assigned based on prioritization ranks.
- Systematic analysis is conducted to evaluate these decision-making tools.
- This kind of budget creates superior and subordinate relations. It also establishes accountability to meet the goals.
- A direct link between the decision-making tools and corporate goals is established.
- The allocation of resources takes place by a variety of tools of decision-making based on the priority that they have been assigned to them.
- It’s an also open-ended method and can be modified according to available resources.
Crucial 5 Steps Involved in Zero Based Budgeting
Here are the critical stages that is involve in the procedure of zero-based Budgeting.
1. Determining the Objectives
There could be a myriad of reasons (like eliminating the line of products, reducing the costs associated with labor or labor, etc.) that are the reason for the zero-based budgets. Also, the identification of the relevant goals helps in the design and implementation.
2. Extent of Coverage
The organization must determine if zero based Budgeting is an excellent idea to be implemented across the entire organization or only in specific areas.
3. Developing Decision Units
Based on the organization’s structure, the functional department, the product lines, or a program can be classified as decision units. So, each decision unit is given a distinct identity.
Based on cost-benefit analysis, the decision is made on which unit to be kept or remove. The analytical calculation is the base of this budgeting method and is beneficial to rank the projects. The next step need not be taken if the unit needs to be eliminated.
4. Developing Decision Packages
This is among the most crucial steps in this process. Zero-based Budgeting is a zero-sum game. After the units are selected to be budgeted, the managers involved are charged with thinking of alternatives that can be realized. The manager is also accountable for conducting a cost-benefit analysis to assist in choosing the most effective option. The manager will also present the overall plan.
5. Preparation of Budget
This is the final stage in the zero-based budgeting process. After the various decision-making packages have been ranked using cost-benefit analysis and availability of funds, A cut-off is determined. Also, the packages within this cut-off are chosen, and the others are turned down. The process of allocation of resources is carried out. Zero-base Budgeting is an extended version of the analysis of costs and benefits.
Major 8 Advantages of Zero Based Budgeting
Zero-based Budgeting has many benefits, including:
1. Alternative Analysis
Zero-based Budgeting demands that managers think of alternatives to accomplish every task. This assists in breaking from a narrow perspective and creates new ways of thinking. The budget will help the company decide whether to run internal production or outsource it to ensure maximum profits.
2. Budget Inflation
Zero-based Budgeting demands that managers be able to link expenditures with activities. This decreases the likelihood of budget inflation since these attempts are easily identified.
3. Communication
Zero-based Budgeting may encourage collaboration between employees since it involves brainstorming and the creation of new ideas to help achieve the company’s goals.
4. Eliminate Non-Key Activities
Zero-based Budgeting can help identify crucial tasks. This removes those activities that are not essential to the nature of their purpose, which aids in the pursuit of economic growth.
5. Mission Focus
It aids managers in identifying the objectives of their departments. Also, Zero-based Budgeting emphasizes the connection between expenditures and activities.
6. Identification of Redundant Activities
Zero based budgeting assists in identifying duplicate tasks and eliminating duplicates. This allows you to concentrate on the main areas of business.
7. Review
Zero-based Budgeting makes sure that all aspects of the organization are regularly reviewed.
8. Resource Allocation
This Zero-based budgeting results in more efficient and effective allocating of resources to different tasks.
Limitations/Disadvantages of Zero-Based Budgeting
The significant disadvantages of zero-based Budgeting can be the following:
1. Bureaucracy
The process of Budgeting that is used for this requires extensive analysis and reporting, which is why it is workforce and human resource high. This increases the cost related to the procedure, reducing the tool’s effectiveness.
2. Intangible Justification
Zero based Budgeting requires justifications for every action and expense. But such reasons can be challenging to come by in areas that need to produce tangible outcomes. For instance, it can take time to establish the ideal amount of research and development.
3. Managerial Time
Zero-based Budgeting can be a lengthy process that could result in managers ignoring their other tasks.
4. Training
Zero-based Budgeting needs proper training to ensure proper execution. This can be time demanding and expensive.
5. Update Speed
Since Zero-based Budgeting can be a long-lasting procedure, the budget will likely be revised regularly to reflect the requirements of new situations. This can impact the effectiveness of the budget negatively.
6. Requires High Managerial Skills
Zero based Budgeting demands a high degree of managerial expertise. Because it requires a lot of time, effort, and money, numerous organizations carry out this process only every few years.