ZERO BASED BUDGETING

SYNOPSIS
The budgeting process is an essential component of management control systems and has been
an effective system by which management can successfully plan, coordinate, and control. The
process involves the creation and implementation of the broad objectives of an organization, the
detailed objectives, and a short-term and long-term financial plan. The philosophy and
procedures used to implement zero-base budgeting in industry and government settings are quite
similar, only slightly differing with the mechanics to fit the specific needs of each organization.

The basic process of zero-based budgeting is to justify budget requests every budgeting cycle,
regardless of prior period budgets. The following sections address the specifics including the
history, implementation, benefits, and drawbacks of zero-based budgeting.

MEANING

Zero-based budgeting is a technique of planning and decision-making which reverses the

working process of traditional budgeting. In traditional incremental budgeting, departmental
managers justify only increases over the previous year budget and what has been already spent is
automatically sanctioned. No reference is made to the previous level of expenditure. By contrast,
in zero-based budgeting, every department function is reviewed comprehensively and all
expenditures must be approved, rather than only increases. ] Zero-based budgeting requires the
budget request be justified in complete detail by each division manager starting from the zero-
base. The zero-base is indifferent to whether the total budget is increasing or decreasing.

The term "zero-based budgeting" is sometimes used in personal finance to describe "zero-sum
budgeting", the practice of budgeting every dollar of income received, and then adjusting some
part of the budget downward for every other part that needs to be adjusted upward.

Zero based budgeting also refers to the identification of a task or tasks and then funding
resources to complete the task independent of current resourcing.

HISTORY OF ZERO-BASED BUDETING

Government budgeting was established in Great Britain in the late 17th century. The enactment
of the 1689 Bill of Rights gave taxing authority to Parliament as opposed to the King. Parliament
gradually established spending programs and by the 1820s published detailed annual financial
statements showing revenues and expenditures and a projected surplus or deficit. The usage of
budgets by the United States government did not begin until 1800 when a law was passed for the
Secretary of the Treasury to submit an annual financial report to Congress. This action was not
taken by the Treasury department, and instead, federal government agencies developed their own
reports and submitted them to the Treasury.

Early business budgets focused on controlling costs and little emphasis on measuring
effectiveness. In the early 1900s, the use of budgets increased due to the necessity for industries
to implement more careful factory planning. A systematic plan of budgeting arose from two
areas: industrial engineering and cost accounting. Scientific methods were used by industrial
engineers to arrive at production standards, which could then be used to estimate future
operations and performance standards. Cost accountants used budgeting to establish standard
costs and to estimate future expected costs in a budgetary form. Also at this time, texts on
budgeting and managerial accounting began to emerge.

As zero-based budgeting gained traction in the 1970s among public budgeting constituents, it
also gained popularity among private enterprises, and during this time a number of organizations
modified and implemented the system. An example of an organization successfully
implementing this system is the Florida Power and Light Company. In 1977 zero-based
budgeting became required for all Florida Power and Light general office staff departments. Ben
Dady, the company's director of management control, favored the system because when
managers develop the zero-based budget, they begin with nothing in terms of budgeted dollars,
and have to justify or prove why they need to spend money on each activity or project for all the
dollars they expect to spend. New and old problems are treated equally. Every managerial
activity is properly identified and then evaluated by analyzing more efficient ways and
alternative levels of performing the same activity. These alternatives are then ranked and relative
priorities are established.

The publicity in the 1970s surrounding zero-based budgeting gave the impression that the system
was a relatively new technique, although the system was not new at all. Zero-based budgeting is
quite similar to the Planning-Programming-Budgeting system, implemented in the 1960s. Both
systems involve evaluating the inputs and outputs for specific activities, as opposed to the
traditional line-item format.

ADVANTAGES

 Efficient allocation of resources, as it is based on needs and benefits.

 Drives managers to find cost effective ways to improve operations.
 Detects inflated budgets.
 Useful for service departments where the output is difficult to identify.
 Increases staff motivation by providing greater initiative and responsibility in decision-
making.
 Increases communication and coordination within the organization.
 Identifies and eliminates wasteful and obsolete operations.
 Identifies opportunities for outsourcing.
 Forces cost centers to identify their mission and their relationship to overall goals.
  Enhances coordination and communication within the enterprise, for positive effects and
better output levels

 Provision for more schemes and responsibilities, to further encourage the staffs

 Compels the spending centers to understand their missions and their inter-relationships,
for achieving overall goals

 Acts as a driving force for managers to search for cost-effective measure to develop the
operations further

 Quick identifications and immediate eliminations of unused and outdated operations

 Recognizing opportunities for financial outsourcings

 Used extensively in the service sectors and departments for easy identification of the
outputs

 Helps in the detection of inflationary budgets

DISADVANTAES

 Difficult to define decision units and decision packages, as it is time-consuming and

exhaustive.
 Forced to justify every detail related to expenditure. The R&D department is threatened
whereas the production department benefits.
 Necessary to train managers. Zero-based budgeting must be clearly understood by
managers at various levels to be successfully implemented. Difficult to administer and
communicate the budgeting because more managers are involved in the process.
 In a large organization, the volume of forms may be so large that no one person could
read it all. Compressing the information down to a usable size might remove critically
important details.
 Honesty of the managers must be reliable and uniform. Any manager that exaggerates
skews the results.
 No proper training of officials on the managerial levels.

 In the micro-management levels, Zero Based Budgeting spends the least amount of time
on issues that really affects the development and progress of a company, and meddles
with trivial issues, which may or may not have any effect on the operations of the
company.

 Forceful justification of all expenditure details is demanded

CHARACTERISTICS

 Requires you to justify and prioritize all activities before allocating any resources.
 All your business forecasts should start from a zero base by justifying all expense
requests in complete detail. The zero base is indifferent to whether the total forecast is
increasing or decreasing
 Requires you to group all relevant activities into decision packages. You justify each in
terms of the companies’ overall business objectives.
 Requires you to rank Packages in order of priority.
 Zero-Base Budgeting is a technique that helps to enhance good planning and decision-
making for your business. In other word, it reverses the working process of the traditional
forecasting methods you may have been accustomed to.
 In the traditional incremental approach, a manager needs to only justify increases over the
previous year’s projections. This means, what has been already spent is automatically
sanctioned. In the case of ZBB, you do not make reference to the previous levels of
expenditure. You must review every business function comprehensively and all
associated expenditures rather than approving only increases.

ZERO BASED BUDGET AND TRADITIONAL BUDGET

Zero Base Budgetineis more or less a self-defining term. As we have discussed earlier. in zero
base budgeting all expenditures are thoroughly analyzed from zero base, such that the current
expenditure levels are justified. In contrast, traditional budgeting usually begins with estimation
of current costs. These estimates serve as the starting point to which management will add data
corresponding to price changes, estimated inflationary uplifts and planned additions, deletions or
alternatives. The assumption is customarily made that current expenditure is justified, such that
only the large budgeted increments from current expenditure levels need to be investigated.
Failure to investigate current expenditure regarding its necessity and effectiveness will lead to
funding of activities for which no increase, or perhaps a decrease in spending is warranted.

Traditional budgeting has not proved to be a suitable tool for shifting resources from low to high
priority areas. It does not involve the same rigorous approach as zero base budgeting and does
not answer the question as to whether we are getting value for the money being spent.

Zero Base Budgeting is a decision-oriented approach and focuses on old and new activities and
connects short and long range goals by monitoring the achievements of objectives. On the other
hand, traditional budgeting is accounting-oriented and focuses on increments and monitors
expenditures.
The logic behind traditional budgeting techniques stresses on three points:

 Last year's spending level is extrapolated into next year,

 Some growth factor is added on account of inflation, increase in prices of raw material
and wages etc.
 Spending level is further incremented for new projects and programmers.

Zero based budget attempts to shift the traditional management approach towards a new mode of
thinking and operation whereby the managers not only justify the new proposals and the funds
required, but also have to justify the ongoing activities and the funds required for them. In other
words, in the conventional budgeting no review of ongoing activities is undertaken.

ACTIVITIES OF ZERO BASED BUDGETING

 Zero Based Budgeting is useful for personal finances, as it describes the budgetary
practice and calculates figures on per unit accumulation of money

 Different financial groups prefer Zero Based Budgets, for assured control on useless
expenditures. This is precisely why it has retained equal popularity in both public and
private commercial sectors, ever since its conceptual inception.

 The preparation of Zero Based Budgeting is supported for the sake of Government
Budgets. Here the expenses tend to become uncontrolled, in trying to maintain parity
between the spending of the last and the current years. In other words, the justification of
a project on government levels is done by this budgeting procedure.

 Zero Based Budgeting offers an overview of the projects with their previous costs, by
dismissing the earlier ones.
MODEL OF ZERO BASED BUDGETS
Major Processes of Zero-Base Budgeting

The development and implementation of the ZBB model requires managers and others in the
organization to engage in several major planning, analytic and decision-making processes. These
major processes of ZBB include the following:

Definition of the Mission and Goals of the Organization

Usually the organization has already established mission and goal statements. However, it may
be necessary to redefine the ones that are already in existence and/or create new ones. This
redefinition is particularly useful when there have been major changes in the internal and
external environment.

Identification of the Organization's Decision Units and Decision Packages

A ZBB decision unit is an operating division for which decision packages are to be developed
and analyzed. It can also be described as a cost or a budget center. Managers of each decision
unit are responsible for developing a description of each program to be operated in the next fiscal
year or years. In ZBB, these programs are referred to as decision packages and each decision
package usually will have three or more alternative ways of achieving the decision package's
objectives. Briefly, each decision package alternative must contain, as a minimum, goals and/or
objectives, activities, resources and their dollar costs. Also, the decision package should contain
a description of how it contributes to the mission and goals of the organization.

Analysis of Each Decision Package

This analytic process allows the manager of the decision package and its alternatives to assess
and justify its operation. Several questions should be asked and answered during the analytical
process.
Ranking of Decision Packages

The ranking process is used to establish a rank priority of decision packages within the
organization. During the ranking process, managers and their staff will analyze each of the
several decision package alternatives. The analysis allows the manager to select the one
alternative that has the greatest potential for achieving the objectives of the decision package.
Ranking is a way of evaluating all decision packages in relation to each other. Since, there are
any number of ways to rank decision packages managers will no doubt employ various methods
of ranking. The main point is that the ranking of decision packages is an important process of
ZBB.

Acceptance and Allocation of Resources

Managers, following a review and analysis of all decision packages, will determine the level of
resources to be allocated to each decision package. Managers at different levels of responsibility
in the organization usually perform the review and analysis. Sometimes, the executive levels of
management may require the managers of the decision packages to revise and resubmit their
decision packages for additional review and analysis.

Budget Preparation

The organization's budget is prepared following the acceptance and approval of the decision

packages. Once the organization's budget has been approved managers of the decision units will

place in operation all approved decision packages during the next fiscal year.

Monitoring and Evaluation

The last major process of ZBB is monitoring and evaluation. The process of planning, analysis,
selection, and budgeting of decision packages prepares the organization for operation during the
next year. However, what managers plan to happen in the next fiscal year may or may not occur.
Adjustments may be essential during the year in order to achieve the decision package
objectives. Also, there is a need to know whether the organization did accomplish what it set out
to achieve and what level of achievement was obtained. The monitoring and evaluation process
of ZBB requires that the following be included in the overall design and implementation of
decision packages. Decision package content should include:

 Measurable performance objectives

 Appropriate activities as means for achieving the performance objectives
 Resource allocation essential for conducting the activities
 Methods for carrying out the activities as planned
 Evaluation of objective achievement during and at the end of the program of activities
 Procedures for reporting objective achievement to managers of the organization

Adherence to concepts and procedures of ZBB will result in the following:

 Adherence to concepts and procedures of ZBB will result in the following:

 Retention of desirable decision packages (including modification as may be necessary)
 Elimination of obsolete, non-relevant decision packages
 Increased or decreased levels of funding for some decision packages
 Addition of new decision packages

The ZBB planning process eliminates one of the major disadvantages of most traditional
management and budgeting systems. Typically, in the traditional budgeting system planners
focus on the incremental cost increases from year to year. ZBB overcomes this traditional
budgeting weakness by subjecting all proposed programs and expenditures to the type of scrutiny
that is normally conducted for new programs. The comprehensive resource cost analysis process
is a strong internal planning characteristic of ZBB.
CONCLUSION

ZBB addresses and supports comprehensive planning, shared decision-making, the development,
and application of strategies and allocation of resources as a way of achieving established goals
and objectives. In addition, ZBB supports the added processes of monitoring and evaluation.
ZBB, when properly implemented provides personnel of an organization to plan and make
decisions about the most efficient and effective ways to use their available resources to achieve
their defined mission, goals and objectives.
BIBLIOGRAPHY

 www.wikipedia.com
 Austin, L. A. 1977. Zero-base Budgeting: Organizational Impact and Effects.
New York: AMACOM.
 Pyhrr, P. A. 1973. Zero-Base Budgeting: A Practical... New York: John Wiley &
Sons.