Zero-Based Budgeting: Meaning and Benefits

Zero-Based Budgeting: Meaning and Benefits

Meaning of Zero-Based Budgeting 

In traditional budgeting, the budget is prepared by making adjustments to the previous year’s budget. In traditional budgeting, the current year’s budget is prepared by adjusting the previous year’s budget based on inflation, market situation, and consumer demand. 

In zero-based budgeting, the budget is prepared from zero. In other words, the budget is prepared from the "zero-base" in zero-based budgeting, and every function is reassessed and revaluated for its costs and needs. 

This method of budgeting originated in the 1960s and was created by Peter Pyhrr, an accounting manager for Texas Instruments. Pyhrr created the zero-based budgeting method to facilitate the incorporation of strategic objectives into the budget by assigning them a specific functional area within the organization. 

The management starts preparing a new budget from scratch, which ensures reduced redundancies in the budget, and ensures that all of the business components are cost-effective, essential, and relevant to the business. 

Characteristics of Zero-based Budgeting 

  • In a company, different departments create decision packages. Decision packages are budget requests which contain the description of a project, its objectives, division of responsibility, etc. In zero-based budgeting, decision packages are evaluated and ranked in order of priority. 
  • In zero-based budgeting, the budget requests are considered after a cost-benefit analysis of the project/program. 
  • Zero-based budgeting forces the decision-makers to evaluate the business's goals and targets and look at the business with a fresh perspective, free from past assumptions. 
  • Zero-based budgeting does consider the previous year’s budget and spending. 

The process of zero-based budgeting

  • Step 1- Zero-based budgeting starts at zero-base. Therefore, all projects, programs, activities, and services are evaluated to reduce and eliminate unnecessary spending and other redundancies. 
  • Step 2- Identify and evaluate decision packages that fulfill the organization's goals and objectives and conforms to the availability of money.
  • Step 3- Once decision packages are identified and evaluated, they are ranked based on prioritization and availability of funds. 
  • Step 4- Once decision packages are ranked and approved in the budget appropriation, funds and resources are allocated, which facilitates the budget's preparation. 

Difference between zero-based budgeting and traditional budgeting 

  • Preparation- Zero-based budgeting requires evaluation and analysis of decision packages. A project is chosen after evaluating its cost-effectiveness. On the other hand, traditional budgeting is prepared after making adjustments to the previous year’s budget. In traditional budgeting, the rate of inflation, market situation, and consumer demand are studied. Therefore, traditional budgeting is a simple process, whereas zero-based budgeting is a complex one. 
  • Approach- In zero-based budgeting, a budget is prepared from scratch and after careful deliberation of decision packages. Whereas in traditional budgeting, the budget preparation approach is evaluating the previous year's budget and making adjustments to that. Therefore, traditional budgeting is based on historical information, and zero-based budgeting is based on estimated information. 
  • Time-effective- Zero-based budgeting is time-consuming, whereas a budget prepared by traditional budgeting methods is less time-consuming. 
  • Allocation of resources- Allocation of resources in a budget prepared by traditional budgeting method is done by making adjustments to the previous year’s budget and doesn’t give priority to vital business activities. Whereas, in a budget prepared by zero-based budgeting method, resources are allocated to the activity which profits the organization the most. 
  • Orientation- Zero-based budgeting is decision orientated, whereas traditional budgeting is accounting orientated. 
  • Justification of projects- In traditional budgeting, justification of expenditure of existing projects is not required. However, in zero-based budgeting, justification of existing and proposed projects is required to analyze their cost-effectiveness and their benefits for the business. 

Benefits of Zero-Based Budgeting for your business 

  • Optimum utilization of funds- In zero-based budgeting, the budget is prepared by evaluating the cost-effectiveness of a program, activity, or service. Therefore, it ensures the optimum utilization of the allocated resources and funds. 
  • Reduced redundancies- Budgets prepared by zero-based budgeting methods reduce redundancies in the budget and ensure that all business components are relevant, cost-effective, and essential. 
  • Motivates employees and fosters better communication- Zero-based budgeting motivates employees to take an active role in decision-making. It also encourages coordination and communication within the departments and with other departments. This practice also links departmental objectives with business objectives. 
  • Cost reduction- In zero-based budgeting, resources are allocated after evaluating the importance and cost-effectiveness of each item. This practice leads to cost reduction and gives an accurate figure of cost against the desired performance. 
  • Reduces wasteful expenditure- It increases participation, reduces wasteful expenditure, and provides flexibility to the budget. 
  • Operational efficiency- It increases business and operational efficiency as it removes redundancies and revaluates past limitations. 
  • Fulfillment of company's goals- Only those projects, items, programs, or activities are chosen which align with the company’s objectives and goals 

Disadvantages of Zero-Based Budgeting  

  • Time-consuming and complex- It is a time-consuming and complex method of budget creation. 
  • Disrupt daily functions- It can be a tedious task that can be emotionally taxing and disruptive towards fulfilling daily goals. 
  • Less emphasis on long-term goals- Zero-based budgeting emphasizes short-term goals over long-term benefits. 
  • Expertise and organizational understanding- It requires years of expertise and understanding of the organizational system to evaluate and rank decision packages effectively. 
  • Cost-ineffective for small businesses- Zero-based budgeting requires a lot of paperwork and effort. For small businesses, zero-based budgeting is cost-ineffective because it requires a lot of planning, researching, and analysis. Traditional budgeting is faster, simpler, and easier to implement. 

A budget prepared by the zero-based budgeting method is more responsive and has more clarity than traditional budgeting, unlike budgets prepared by traditional budgeting methods, budgets prepared by zero-based budgeting concentrate on making a new economic proposal rather than stressing former expenditure levels. 

While the zero-based budgeting process is tedious, complex, time-consuming, and cost-ineffective, they weed out redundancies from the budget, reduce wasteful expenditure, motivate employees to participate in decision-making, and increase business and operational efficiency. 

The traditional budgeting method is a simple method that is outdated and which doesn’t serve the company. On the other hand, zero-based budgeting removes redundancies and wasteful expenditure from the budget and results in better allocation of funds.

Countless companies rely completely on outsourcing accounting firms for a long time. In this way, they have saved a lot of money as well as time. Hopefully, the article was helpful to you. And has helped you show all the positives of outsourcing accounting. For more details or any query, reach us at  hgoyal@especia.co.in or 9310165114.



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