Intro:
Zero-based budgeting (ZBB) is a form of budgeting that allocates funds based on the effectiveness of a program instead of using historical data.
Unlike the traditional budget method expenses aren’t automatically added to the budget because they were previously included in the budget, in Zero-based budgeting every program and expenditure gets reviewed at the start of each budget cycle, therefore every line item needs to be justified in order to receive funds.
Zero-based budgeting can produce major savings for the organisation when used correctly as some line items may drain funds from the organisation without being linked to a revenue-generating item.
Zero-based budgeting vs Traditional budgeting:
With traditional budgeting, incremental increases occur with every new budgeting cycle (for example an increase of 3% in spending) rather than there being a valid reason for either new or old expenses as per ZBB.
Traditional budgeting mainly analyzes new expenditures, whereas ZBB starts from Zero and there needs to be a valid reason for all expenses.
ZBB aims to put the onus on those charged with creating the budget to justify expenses and increase value for the organisation by creating a more efficient budget.
How to create a Zero-based budget:
There are various ways of putting together a Zero-based budget but this is how we normally do it.
- Step 1 – Identify your revenue streams
- Step 2 – Identify your expenses
- Step 3 – communicate with suppliers and try and convert fixed costs to variable costs
- Step 4 – link each expense to a revenue stream
- Step 5 – Cancel any expense that has not been allocated
Benefits of Zero-based budgeting:
ZBB offers numerous advantages including lower costs and a flexible budget that encourages focused operations.
When those charged with creating a budget approach every dollar disbursed in relation to how much revenue it generates then the highest revenue-generating operations become the primary focus. Zero-based budgeting prevents the misallocation of funds which will result in lowered costs and increased profits.
Disadvantages of Zero-based budgeting:
ZBB requires you to take time to review the income and expenses and this can be time-consuming for some people, this might not be worth it. Since revenue-generating expenses are prioritised over those that are not directly linked to a revenue stream certain expenses, such as research and development, that are essential to the growth of the business might be overlooked and this could result in the organisation not spending enough on growth-focused costs.
