Zero-based budgeting is an approach to budgeting that starts with a blank piece of paper every accounting period. Resources are allocated on needs rather than past budgeted information.
Zero-based budgeting (ZBB) is very distinctive; the past is not taken into consideration when setting new budgets. Every year a new budget is created which reflects the current environment to which they are working in.
Zero-based budgeting is more popular with larger organizations than medium-sized ones.
The basic idea is that every year you start with a blank piece of paper and focus on what drives the resources. This type of budgeting is not as popular as rolling budgets because it is more relevant to organizations that do not have processes and businesses which are repeated on an annual basis. It is often associated with the public sector. This type of budgeting is easier to achieve with services or discretionary costs.
With traditional budgeting there is an incremental approach, the baseline is accepted from previous year and managers are only expected to justify any changes based on the predicted and the actual budget. With ZBB, variances on every item are required to be justified on a yearly basis. The concept is that resources will be allocated where they are needed.
In general the process of using ZBB comprises three steps:
- All activities within the organization need to be identified. For each activity a report needs to be generated to analyze the costs, justify the reason for the activity to go ahead and to present all alternatives. At this stage appropriate targets should be identified as a performance tool. These activity reports are commonly referred to as ‘decision packages’.
- Every activity report will then be given due consideration and they will be ranked in order of what is required for the forthcoming budget period.
- The final stage is the allocation of resources which is determined by the ranking performed in stage 2.
Advantages and Disadvantages
Advantages and disadvantages of zero-based budgeting are listed in Figure 1.
Figure 1: Advantages and disadvantages of ZBB