Zero-based budgeting (ZBB) is a budgeting technique in which every expense must be justified for each new period. Unlike traditional budgeting, where existing spending levels are used as a baseline, in zero-based budgeting, every function within an organization is analyzed for its needs and costs. Therefore, all expenses must be justified for each new period, regardless of the budget history.
Here’s how zero-based budgeting works:
- Identification of Activities: Every task or activity within an organization is identified, and decision packages are created for each one.
- Evaluation and Ranking: Decision packages are then evaluated and ranked based on their importance and contribution to the organization’s objectives. Each package is scrutinized to determine its necessity and cost-effectiveness.
- Resource Allocation: Resources (budget allocation) are then allocated based on the priority of the decision packages. The packages are funded based on their importance to the organization.
- Continuous Review: Zero-based budgeting requires continuous review and justification of expenses, encouraging managers to find more efficient ways of running operations.
Benefits of Zero-Based Budgeting:
- Increased Efficiency: By scrutinizing every expense, organizations often find areas where cost efficiencies can be achieved, leading to cost savings.
- Resource Optimization: Resources are allocated based on current needs and priorities rather than historical allocations, ensuring optimal resource utilization.
- Cost Reduction: Zero-based budgeting can lead to the identification and elimination of unnecessary or redundant expenses, leading to cost reduction.
- Enhanced Accountability: Managers are accountable for justifying every expense, promoting a culture of responsibility and accountability within the organization.
However, implementing zero-based budgeting can be time-consuming and resource-intensive due to the detailed analysis required for each activity. As a result, organizations often use a combination of zero-based budgeting and traditional budgeting techniques to strike a balance between thorough expense analysis and practicality.