The concept of Zero Based Budgeting
Zero Based Budgeting is a method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a ‘zero base’ and every function within an organization arc analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one. ZBB allows top-level strategic goals to be implemented into the budgeting process by tying them to specific functional areas of the organization, where costs can be first grouped, then measured against previous results and current expectations. It aims to put the responsibility on managers to rationalize expenses and aims to drive value for an organization by optimizing costs and not just revenue.
The basic process flow under zero-base budgeting is:
- Classify business objectives,
- Create and estimate substitute methods for accomplishing each objective,
- Evaluate option funding levels, depending on planned performance levels,
- Set priorities.
Unlike the traditional (incremental) budgeting in which past sales and expenditure trends are assumed to continue, ZBB requires each activity to be justified on the basis of cost-benefit analysis, assumes that no present commitment exists and that there is no balance to be carried forward. By forcing the activities to be ranked according to priority. ZBB provides a systematic basis for resource allocation. Under this method, every activity needs to be justified, explaining the revenue that every cost will generate for the company.