Budgeting Techniques/Systems : Zero-Based Budget/Budgeting Definition (Part 2)

In this part of the article, we shall discussed not the traditional type of budgeting but rather look at other alternatives and contemporary type of budgeting.
 One of these alternatives is the Zero-based budgeting.
Introduction to Zero-based budgeting:

Zero based budgeting is not at all new. It was started in government budgeting in Great Britain and in 1962, the US Department of Agriculture devised the zero-based budgeting approach.

Zero Based Budgeting is an approach to budgeting that starts from the premise that no costs or activities should be factored into the plans for the coming budget period, just because they figured in the costs or activities for the current or previous periods. Rather, everything that is to be included in the budget must be considered and justified.

Zero-based budgeting naturally has always being vogue with management and usually is their keynote during the annual budget preparation .

They will always caution those preparers of annual budget: “ to justify each item of expenditure and avoids the mindset of accepting last year’s expenses as the starting point and then add some % factor into them.

Let starts with the various advantages of using Zero-based budgeting approach:

• The main benefit is to focus attention on the actual resources that are required in order to produce an output or outcome, rather than the percentage increase or decrease compared to the previous year. More importantly, it complies with management’s directive not to blindly follow last year figure;It can be useful for shaking up a process that may have grown stale and counterproductive over time.
• By starting at zero, it therefore increased all level of managers’ awareness first to identify their specific objectives, quantify them and consider the most cost effectiveness ways of achieving them which can lead to better resource allocation
• Is an adaptive approach to changing circumstances

 

• From a practical standpoint, if initially a company have utilised the traditional approaches of adding % to last year figure and then revert to zero based, normally they will be quite astonished to see expenses which in the first place should not be there. Hopefully, they will question these detailed costs. This therefore facilitates participation in the budgeting process;
• Generally report some improvement quantitatively or qualitatively. That is, the process has either saved money, improved services, or both.
• Make budget discussions more meaningful during review sessions.
• It is more user friendly to operational managers than the traditional incremental budget model. It moves the process away from the bookkeeper’s number crunching spreadsheets, and engenders a balanced partnership between the finance professionals and the budget holders in the analytical and decision-making processes

Next, what are the limitations or disdvantages of using  zero-based budgeting:

• May increase the time and expense of preparing a budget. This is particularly true as it takes a lot of managerial time. It takes a considerable amount of time to go through the process of reviewing operations in enough detail to justify costs each budget cycle without relying on past expenditures.
• Can make matters worse if not done in the right way. A substantial commitment must be made by all involved to ensure that this doesn’t happen.
• The success of adopting zero-based budgeting hinges strongly on leadership that is dedicated to the task. It is important that the reviewer of the budget should not have a pecuniary interest in maintaining the status quo. If we involved people with self interest in the zero based budgeting, this will prove counterproductive as they will be very defensive to protect their interests.
• As zero based budgeting involves a lot of time, it should not be conducted for every department, every year. Such a move may prove impossible to manage. Hence we should only choose several departments/divisions and by rotation basis.

Perhaps, a solution to onerous burden of preparing zero-based budgeting is that instead of re-establishing each line of expenditure from zero, the reverse approach is to have the last year figures and then deduct out all known and major expenditures and leaves with it the minimum operating expenditure of the company. By using this so-called working backward approach, much time is saved.

Another solution to this problem is to create a rolling budget every year and perform a zero-based budget every three to five years, or when a major change occurs within the operation. This allows an organization to benefit from the advantages of zero-based budgeting without an excessive amount of work.

• The Various Types Of Budgeting Process/Techniques/Systems (Part 1)
• What is Activity based budgeting and briefly describe how it could bring improvements to the budgeting process of an organization
• Limitations Of Zero-based-budgeting system
• Activity Based Costing As a One Step Attribution System Compared To Other Traditional Systems
• Introduction to Using Web-based Accounting Systems As Part Of Work Flow Efficiency ( Part 1)
• Using The Internet or Web-Based Accounting Package Systems (Part3)–Features To Consider When Buying The Software
• What Is Meant by Asset-based Finance? What Are some of the differences between Asset-based finance and Cash Flow-based Loans/Finance