What is Zero Based Budgeting? How to Do Zero Based Budgeting (ZBB)?

Zero-Based Budgeting is a concept in management accountant where the company budgets are drawn up from scratch. The company might or might not be having a budget from the previous year, however, the company can still engage in Zero-Based Budgeting.

Usually, an annual budget is based on either the previous year budget or the previous year actual financials. However, in this concept, the budget is based on '0' value, hence all revenues and costs have to be justified from the start.

Why Zero-Based Budgeting?

A Zero-Based Budget could be adopted by a company for various reasons. If a company is just starting their budgets for the first time, they have to adopt a Zero-Based Budget. However, if a company has been practicing budgeting for a while and still decides on ZBB, it could be attempting to fix a mistake in budgeting, due to drastic changes in the organization or to re-validate their revenue/cost structure.

How to Perform Zero Based Budgeting?

There are several steps involved in ZBB which must be followed to derive optimum results.

1. Identify revenue components and cost components
2. Looking at ways of achieving these revenue and cost components
3. Evaluating options--this is where the numbers are considered for the budget. Hence, each and every revenue and expense has to be justified, in comparison with alternative options.
4. Putting the numbers to the budget

Example of Performing Zero-Based Budget

Company 'A' had a budget for financial year (FY) 2017. However, if the company wishes to develop a Zero-Based Budget for FY 2018, they will have to scratch off the last year's budget completely and start from zero. First of all, the company has to look at their revenue avenues and assign numbers by justifying them. The justification should be supported by contracts and communications with marketing staff. 

Next, they have to look at the costs associated with the revenues and evaluate different options of spending. The company has to evaluate these options and decide on the best choice. The company may have to call up proposals from different vendors/stores to compare prices/quality/specifications and decide on the best options for the company. This means that the company will not rely on last year's quotations or prices or costs for the next year's budget.

Advantages of Zero-Based Budgets

1. Figures would be more accurate and timely
2. Redundant costs will be removed from budgets or heavily slacked
3. Budget will reflect the true situation of the company in the year to come
4. Any structural changes can be easily included into the budget
5. Goal/objective driven
6. Likely to cause an improvement in profitability over last year's budgets
7. Ability to discover hidden costs/wastage/improvement opportunities in the business

Disadvantages of Zero-Based Budgets

1. Quite time consuming since all costs and revenues have to be evaluated and justified
2. Might be expensive to formulate the budget
3. The budget will lack prior budget's expertise
4. Might be difficult to achieve the budget since ad-hoc costs could occur

It is also noteworthy that Zero-Based Budgeting is most applicable in deriving the figures for costs, which is the area of the company that needs the most attention.

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