Zero-based budgeting, or a zero-based budget, requires that all managers’ budgeted expenses be justified, rather than requiring justification only for increases over the previous year’s budget, which is the most common approach.
Zero-based budgeting is a method of preparing operating plans and cash flow budgets that must start from scratch every year, with no pre-authorized funds.
With traditional budgeting, past trends in sales and spending are taken as given – assumed to continue.
With zero-based budgeting (ZBB), each activity must be justified on the basis of a cost-benefit analysis. When the ZBB accounting method is used, it is assumed that no current commitment exists – there is no balance that needs to be carried forward.
At the start of each period, a manager is theoretically assumed to have a baseline, with respect to expenses, of zero – hence the name âzero-based budgetâ.
With a traditional budgeting system, you post numbers from previous periods and only negotiate if you want this amount to be changed. With a zero-based budgeting system, each accounting period begins with zero – all digits are erased. Thus, each expense should be fully evaluated from scratch.
Focus on key business goals
ZBB’s goal is to continually refocus funding on key business goals and reduce or cancel all activities that are not related to those goals.
According to McKinsey & Company, a multinational management consulting company:
âZero-based budgeting is a repeatable process that organizations use to rigorously review every dollar in the annual budget, manage financial performance on a monthly basis, and create a culture of cost management among all employees. “
“A world-class ZBB process relies on developing deep visibility into cost drivers and using that visibility to set ambitious but credible budget targets.”
AccountingTools.com says that in a zero-based budgeting system, the basic process flow is:
– Prioritize business objectives.
– Create, evaluate and evaluate alternative methods to achieve each objective.
– Examine alternative funding levels, based on expected performance levels.
Bain & Company, an American global management consulting firm , writes: âIn our experience, zero-based budgeting (ZBB) offers companies a convenient way to radically rethink their cost structures, reducing expenses on overhead and support functions by up to 25%, while increasing efficiency and competitiveness. “(Image: adapted from bain.com)
Zero-based budget and threat of recession
For many businesses, the idea of âârebuilding the budget from scratch can be seen as a nightmare – wiping the budget slate and starting over is a last resort; never something a senior manager would consider doing under normal circumstances.
However, as of 2008, an increasing number of business enterprises have chosen to do just that. In the face of the Great Recession, businesses began to turn to zero-based budgeting.
The zero-based budgeting process is a process that allocates funds, not based on budget history, but based on the effectiveness and necessity of the program.
Budgetists review every program and every expense at the start of every fiscal year. Each position must be justified in order to approve its funding.
ZBB can be applied to any type of cost, including operating expenses, sales, capital expenses, marketing, variable distribution, or cost of goods sold.
Deloitte Touche Tohmatsu Limited (Deloitte), a multinational professional services company incorporated in the UK, writes:
âIf successful, ZBB generates radical savings and frees organizations from entrenched departments and methodologies. If this fails, the costs to an organization can be considerable.
Zero-based budgeting in the 1970s
Zero-based budgeting first gained prominence in the public sector during the financial crisis of the 1970s. As public pressure increased, US President Jimmy Carter vowed to reform the federal budget system and balance the federal budget using the ZBB. When he was governor of Georgia, Carter had used ZBB.
Although it was well received in the beginning, the ZBB proved not only to be time consuming and incredibly complicated, but also inefficient, as it was Congress and the executive that ultimately decided which programs were kept and which were eliminated. .
President Carter’s budget office used a variant of the ZBB, in which agencies were required to categorize their programs with funding limits. This forced them to assign priorities and identify reduction targets. However, rather than starting from a true zero base, the agencies started from a âpriority baseâ.
President Ronald Reagan abandoned the system shortly after taking office in 1980. âSince then, the use of ZBB in the public and private sectors has been limited due to its high level of complexity and importance. required investment that may hinder its execution, âwrote Deloitte.
Video explaining zero-based budgeting
This Stroud International The video explains what zero-based budgeting is, a system created by Pete Pyhrr of Texas Instruments in the 1960s.