Zero-Based Budgeting is a method of budgeting in which all expenses must be justified for each new period. The process of zero-based budgeting starts from scratch “(zero base)”, and every function within an organisation is analysed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether each budget is higher or lower than the previous one.
In the current scenario because of hectic competition, worldwide inflation, technological advancement, and soaring costs of production, no organisation can survive and thrive unless it adopts a pragmatic and effective approach to the budgeting system. Developing and adopting a budget is perhaps the single most important as well as time-consuming activity of an organisation whether in a Government, Public Sector Companies (PSU) or Private Sector Company. However, developing countries, like India, have been facing several fiscal constraints due to rising demands for more and better public services. Zero- Based budgeting is an important technique in which unnecessary expenditures are eliminated from the proposed budget. Performance Budgeting and Zero-Based budgeting are the special budgeting techniques used by government departments and companies.
Characteristics of Zero-Based Budgeting
- Justifies the resources requirements for various levels of existing activities as well as for new activities.
- Forms the justification on the evaluation of discreet programmes and activities or other functions of each decision unit.
- Use decision packages as the major tool for the budgetary review analysis and decision making.
- Ranks the programmes, activities, and funding levels and reallocates resources in order of priority.
5 Steps of Zero-Based Budgeting
The following 5 steps can provide a baseline for implementation:
- START: Begins at ground zero. Create a new annual budget from scratch without using last year’s actuals as a baseline.
- EVALUATE: Evaluate every cost area. Eliminate and reduce unnecessary activities or services.
- JUSTIFY: Account for all components of the budget. Identify areas that are cost-effective, relevant, and that derive cost savings.
- STREAMLINE: Determine what activities should be performed and how. Automated and standardized processes were possible.
- EXECUTE: Roll out of comprehensive planning and execution processes. Communicate clear plans, roles and responsibilities.
How traditional budget is different from a Zero-Based Budget?
|Basic Difference||Traditional Budgeting||Zero-Based Budgeting|
|EMPHASIS||It is accounting-oriented, with an emphasis on “How much”.||It is more decision-oriented, with emphasis on “why”.|
|APPROACH||It is monitoring the expenditures.||It is towards the achievement of objectives.|
|FOCUS||To study the changes in the expenditures.||To study the cost-benefit analysis.|
|COMMUNICATION||It operates only through vertical communication.||It operates in both directions horizontally and vertically.|
|METHOD||It is based on the extrapolation i.e. from the yester figures to future projections.||Its decision package is totally based on the cost-benefit analysis.|
Merits of Zero-Based Budgeting
Accuracy: Against the regular methods of budgeting that involve just making some arbitrary changes to the previous year’s budget, zero-based budgeting makes every department relook each and every item of the cash flow and compute their operation costs. This to some extent helps in cost reduction as it gives a clear picture of costs against the desired performance.
Efficiency: This helps in the efficient allocation of resources (department-wise) as it does not look at the historical numbers but looks at the actual numbers.
Reduction in redundant activities: It leads to identifying opportunities and more cost-effective ways of doing things by removing unproductive or redundant activities.
Budget inflation: Since every line item is to be justified, a zero-based budget overcomes the weakness of incremental budgeting of budget inflation.
Coordination and Communication: It also improves coordination and communication within the department and motivates employees by involving them in decision-making.
Although zero-based budgeting merits make it look like a lucrative method, it is important to know the disadvantages.
Zero Based Budgeting Disadvantages
Time-Consuming: Zero-based budgeting is a very time-intensive exercise for a company or a government-funded entity to do every year as against incremental budgeting, which is a far easier method.
High Manpower Requirement: Making an entire budget from the scratch may require the involvement of a large number of employees. Many departments may not have adequate time and human resources for the same.
Lack of Expertise: Explaining every line item and every cost is a difficult task and requires training the managers.
Author Details: Anuradha Designation: Anuradha is Research Assistant at ADRI, Patna