What is zero based budgeting
It is a method of budgeting that requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time.
What is the three step approach to implementing a Zero Based Budget.
- Define the decision packages
- Evaluate and rank each activity
- Allocate recourse
Explain the process in decision packages
All activates are subject to the most basic scrutiny, and answers sought to such fundamental questions as:
(a) Should the activity be undertaken at all
(b) If the company undertakes the activity, how much should be done and how well should it be done. (I.E economy or deluxe services)
(c) How should the activity be performed – In house or subcontract
(d) How much would the various alternative levels of service and provision cost
To answer the above questions, all existing and potential organisational activates must be describes and evaluated in a series of decision packages, giving the following four step process to a ZBB exercise
(1) Determine the activates that are to be used as the object of a decision package and identify the managers responsible.
(2) Request the managers identified above prepare a number of alternative decision packages
(3) Rank the decision packages in order of their contribution towards the organisations objectives
(4) Fund the decision package in accordance to the agreed ranking
What are the advantages and disadvantages of Zero Based Budgeting
Advantages
- It helps to create an organisational environment where change is accepted
- It helps managers to focus on company objectives and goals. It moves budgeting away from number-crunching, towards analysis and decision making
- It focus on the future rather than the past
- It helps identify inefficient operations and wasteful spending, which can be eliminated
- Establishing priorities for activates provides a framework for the optimum utilisation of resources. This assists decision makers when some expenditures are discretionary.
- It establishes a measure of performance for each decision package. This measure can be used to monitor actual performance and compare actual with budget.
- It involves managers in the budget process. Unlike incremental budgeting, it is not a desk bound exercise driven by the accounting department.
Disadvantages
- It is a time consuming exercise. It is unlikely that an organisation will have to carry out ZBB every year.
- There is a temptation to concentrate on short term cost savings at the expense of longer term benefits
- It might not be useful for budgeting for production activates or service provision, where costs and efficiency levels should be well controlled, so that budgets can be prepared from forecasts of activity volume and unit costs.
- In applying ZBB ‘activities’ may continue to be identified with traditional functional departments, rather than cross-functional activities, and thus distract the attention of management from the real cost-reduction issue. For example, it could be argued that the costs incurred in a warranty department are largely a function of the reliability of products, which itself is a function of actions and decisions take elsewhere. If the warranty department is treated as an activity for ZBB, the focus of the decision packages is likely to be on providing the same level of customer service at reduced cost , or enhancing the level of customer service for the same cost. The main driver behind the departments cost-product reliability – may remain unaddressed in ZBB as it is with the blanket cut approach.
- It might require skills from management that the management team does not possess
- The ranking process can be difficult, since widely-differing activities cannot be compared on quantitative measures alone. For example it might be difficult to rank proposals for spending on better service quality, improvements in safety in the work place or more spending on new product development
