Published On:Saturday, 24 December 2011
Posted by Muhammad Atif Saeed
Zero-Base Budgeting
Overview of Zero-Base Budgeting
A zero-base budget requires managers to justify all of their budgeted expenditures, rather than the more common approach of only requiring justification for incremental changes to the budgetof the preceding year. Thus, the manager is assumed to have an expenditure base line of zero (hence the name of this budgeting method).
The budgeting procedure under zero-base budgeting requires a considerable amount of supporting paperwork. Not only does a manager have to prepare the usual level of revenue and expendituredetail that are called for in a normal budget, but must also prepare a ranking of department activities, itemizing the cost of each activity and its importance. The manager must also identify what happens if expenditure levels vary for a given activity (such as for reductions of 25%, 50%, and 75%).The management team uses this information to decide whether it should drop certain activities entirely, along with their associated costs, or to pare them back to reduced expenditure levels.
Problems With Zero-Base Budgeting
The main downside of zero-base budgeting is the exceptionally high level of effort required to investigate and document department activities; this is a difficult task even once a year, which causes some entities to only use the procedure once every few years, or when there are significant changes within the organization. Another alternative is to require the use of zero-base budgeting on a rolling basis through different parts of a company over several years, so that management can deal with fewer such reviews per year. Other drawbacks are:
- Gamesmanship. Some managers may attempt to skew their budget reports to concentrate expenditures under the most vital activities, thereby ensuring that their budgets will not be reduced.
- Intangible justifications. It can be difficult to determine or justify expenditure levels for areas of a business that do not produce “concrete,” tangible results. For example, what is the correct amount of marketing expense, and how much should be invested in research activities?
- Managerial time. The operational review mandated by zero-base budgeting requires a significant amount of management time.
- Training. Managers require significant training in the zero-base budgeting process, which further increases the time required each year.
Advantages of Zero Based Budgeting
There are a number of advantages to zero-base budgeting, which include:
- Alternatives analysis. Zero-base budgeting requires that managers identify alternative ways to perform each activity (such as keeping it in-house or outsourcing it), as well as the effects of different levels of spending. By forcing the development of these alternatives, the process makes managers consider other ways to run the business.
- Budget inflation. Since managers must tie expenditures to activities, it becomes less likely that they can artificially inflate their budgets – the change is too easy to spot.
- Communication. The zero-base budget should spark a significant debate among the management team about the corporate mission, and how it is to be achieved.
- Eliminate non-key activities. A zero-base budget review forces managers to decide which activities are most critical to the company. By doing so, they can target non-key activities for elimination or outsourcing.
- Mission focus. Since the zero-base budgeting concept requires managers to link expenditures to activities, they are forced to define the various missions of their departments – which might otherwise be poorly defined.
- Redundancy identification. The review may reveal that the same activities are being conducted by multiple departments, leading to the elimination of the activity outside of the area where managements wants it to be centered.
- Required review. Using zero-base budgeting on a regular basis makes it more likely that all aspects of a company will be examined periodically.
- Resource allocation. If the process is conducted with the overall corporate mission and objectives in mind, an organization should end up with strong targeting of funds in those areas where they are most needed.
