Zero-Based Budgeting

A budget starting from scratch

What is Zero-Based Budgeting (ZBB)?

Zero-based budgeting (ZBB) is a budgeting technique that allocates funding based on efficiency and necessity rather than budget history. Management will start from scratch and develop a budget that only includes operations and expenses critical to running the business; there are no expenses that are automatically added to the budget.

All these expenses must be justified to remain in the budget. For example, if a company expects to incur $100,000 in salaries and wages and believes that the full $100,000 is absolutely necessary to run the business smoothly, it will stay in the budget.

However, if instead of paying salaries, the company could substitute technology to reduce these expenses, adjustments would be made accordingly.

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Zero-Based Budgeting vs Traditional Budgeting

All businesses use budgets to keep track of expenses and improve ways to minimize costs and maximize profit. Budget amendments are usually based on budgets from previous years. In fact, traditional budgeting implements incremental increases or decreases in the previous years’ budgets by a certain percentage to meet new goals. These percentages usually range anywhere from 1% to 10%.

Sometimes, budgets can get out of control or in some years, may show significantly higher or lower costs depending on the overall market outlook and other external factors. In these scenarios, it does not make sense to look at last year’s budget. The entire budget needs to be redone from scratch, hence, a zero-based budget.

In a zero-based budget, the company uses the current year’s information and analyzes every expense/aspect of the business one by one. This is referred to as starting from a “zero base.” While zero-based budgeting examines all expenses, traditional budgeting only examines new expenses.

 

zero-based budgeting

 

Advantages of Zero-based Budgeting

  • The final output is well justified and is aligned with the overall business strategy.
  • Encourages more collaboration throughout the company
  • Improves performance and operating efficiency by challenging assumptions
  • By avoiding traditional budgeting percentage increases, there is a higher chance of overall cost reductions.

 

Disadvantages of Zero-based Budgeting

  • Implementing a zero-based budget requires qualified personnel and specialized training, which can be time-consuming and costly.
  • May harm the company’s overall culture or brand image
  • May be cost-prohibitive for companies with minimal available funding
  • Costly, complex and tedious to start from a zero base. Traditional budgeting is much simpler, faster, and easier to implement.

 

Final Thoughts

To sum up, although zero-based budgeting is an option for companies that can create numerous benefits, they are also associated with some potential drawbacks.

Implementing zero-based budgeting is not solely an accounting decision and must be considered in conjunction with the company’s overall business strategy and goals. While a zero-based budget may help companies better reduce costs, they may completely change the value of the company and its culture.

For example, if companies rely heavily on maintaining a positive, vibrant and accessible environment for its employees but all the expenses to maintain this environment were eliminated due to the zero based budget process, the overall culture of the company may change. This change not only leads to high turnover rates but results in different products and brand perceptions.

According to a study by Accenture, only about 50% of companies can sustain cost savings for one to two years, and in such cases, traditional budgeting becomes ineffective.

Zero-based budgeting must be a collaborative, unanimous decision within the company after careful consideration of all its advantages and disadvantages.

To learn more, check out our budgeting and forecasting course now!

 

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