Zero Based Budgets

Zero-based budgeting starts from a “zero base” and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one. Because of its detail-oriented nature, zero-based budgeting may be a rolling process done over several years, with only a few functional areas reviewed at a time by managers or group leadership. Zero-based budgeting can lower costs by avoiding blanket increases or decreases to a prior period’s budget.

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It is, however, a time-consuming process that takes much longer than traditional, cost-based budgeting. The practice also favors areas that achieve direct revenues or production; their contributions are more easily justified than in departments such as client service and research and development. The name zero base budgeting derives from the idea that such budgets are developed from a zero base: that is, at the beginning of the budget development process, all budget headings have a value of ZERO.

This is in sharp contrast to the incremental budgeting system in which in general a new budget tends to start with a balance at least equal to last year’s total balance, or an estimate of it. What zero base budgeting tries to achieve is an optimal allocation of resources that incremental and other budgeting systems probably cannot achieve. ZBB starts by asking managers to identify and justify their area(s) of work in terms of decision packages (qv). Zero-based budgeting is an approach to planning and decision-making which reverses the working process of traditional budgeting.

In traditional incremental budgeting, departmental managers justify only variances versus past years, based on the assumption that the “baseline” is automatically approved. By contrast, in zero-based budgeting, every line item of the budget must be approved, rather than only changes. [1] During the review process, no reference is made to the previous level of expenditure. Zero-based budgeting requires the budget request be re-evaluated thoroughly, starting from the zero-base. This process is independent on whether the total budget or specific line items are increasing or decreasing.

Advantages 1. Efficient allocation of resources, as it is based on needs and benefits rather than history. 2. Drives managers to find cost effective ways to improve operations. 3. Detects inflated budgets. 4. Increases staff motivation by providing greater initiative and responsibility in decision-making. 5. Increases communication and coordination within the organization. 6. Identifies and eliminates wasteful and obsolete operations. 7. Identifies opportunities for outsourcing. 8. Forces cost centers to identify their mission and their relationship to overall goals. . It helps in identifying areas of wasteful expenditure and, if desired, it can also be used for suggesting alternative courses of action. One drawback to zero-based budgeting is cost in terms 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. One 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. Likewise, traditional rolling budgets should never strictly rely on a prior-year budget plus a percentage; consideration should always be given to past numbers. In some cases, a zero-based budget may rely on some prior numbers where it is overwhelming to create a budget from scratch. Ultimately, the process gives top management the opportunity to judge the performance of managers in terms of allocating resources efficiently and effectively, and gives managers more responsibility in developing their budgets.

An organization should not feel that all budgets must be developed in entirely the same manner. Some departments can utilize an in-depth study of a zero-based budget while others can use a rolling budget. This is a way to spread the extensive work over a number of years instead of concentrating on one certain year. Many organizations have implemented the system in some form or another and found that it did not work. If properly implemented, however, the process could have a considerable improvement over traditional rolling budgets.

The number and nature of decision packages varies from organization to organization; it is not uncommon for large organizations to identify several thousand packages. Furthermore, it is often hard or even impossible for top executives to have the necessary knowledge or time to develop and rank priorities for thousands of packages. To alleviate this problem, managers, after ranking their own packages, can have their top executives rank the packages of all the managers that report to them. This approach is used by one of zero-based budgeting’s pioneers, Texas Instruments.

Another solution is for each level of management to rank a certain percentage of packages within its own area of responsibility. In this solution, the first level of management may rank 40 percent of the proposed packages; the next level may rank the next 40 percent of packages, while top management may concentrate on the remainder of the budget Read more: Zero-Based Budgeting – strategy, organization, levels, system, style, examples, advantages, manager, company http://www. referenceforbusiness. com/management/Tr-Z/Zero-Based-Budgeting. html#ixzz1TgZFF400 [edit] Disadvantages . More time-consuming than incremental budgeting. 2. Justifying every line item can be problematic for departments with intangible outputs. 3. Requires specific training, due to increased complexity vs. incremental budgeting. 4. In a large organization, the amount of information backing up the budgeting process may be overwhelming. The zero-based budgeting system puts the burden of proof on the manager, and demands that each manager justify the entire budget in detail and prove why he or she should spend the organization’s money in the manner proposed.

A “decision package” must be developed by each manager for every project or activity, which includes an analysis of cost, purpose, alternative courses of action, measures of performance, consequences of not performing the activity, and the benefits. This approach is different than traditional budgeting techniques due to the analysis of alternatives. Managers must identify alternative methods of performing each activity first, such as evaluating the costs and benefits of making a project or outsourcing it, or centralizing versus decentralizing operations.

In addition, managers must identify different levels for performing each alternative method of the proposed activity. This means establishing a minimum level of spending, often 75 percent of the current operating level, and then developing separate decision packages that include the costs and benefits of additional levels of spending for that particular activity. The different levels allow managers to consider and evaluate a level of spending lower than the current operating level, giving decision-makers the choice of liminating an activity or the ability to choose from a selection of levels of effort including tradeoffs and shifts in expenditure levels among organizational units. The decision packages must be ranked in order of importance once they have been created. This allows each manager to identify priorities, combine decision packages for old and new projects into one ranking, and allows top management to evaluate and compare the needs of individual units or divisions to make funding allocations. In this respect, zero-based budgeting is quite different than traditional rolling budgets.

Rolling budgets often appeal to people who prepare budgets because they make budget development much easier. Managers can add an inflation factor to the previous year’s budget and then include any adjustments for major changes. Rolling budgets also give management a concrete number to help make comparisons from year to year. However, traditional rolling budgets have a tendency to create conflict; they can create an incentive to spend money carelessly in order to justify the next year’s budget.

They can also create inefficient operations due to the fact that individual departments or units do not have to justify expenditures based on operations, but only on the prior year’s expenditures. Zero-based budgeting addresses such problems that can occur with traditional rolling budgets. In zero-based budgeting, each dollar spent by management must be justified with a detailed account of what will be purchased, how many labor hours are needed, what problems will be faced, and so forth. This allows management an opportunity to review operations in depth and make recommendations for changes to if necessary.

The zero-based budgeting process helps managers identify redundancies and duplications among different departments, concentrating on the dollars needed for proposed programs as opposed to percentage increases or decreases form the previous year. Specific priorities of departments and divisions are identified more easily in zero-based budgeting. The process also allows for the comparability of different departments as to the respective priorities funded. Zero-base budgeting enables a performance audit to determine whether each project or activity has been performed as efficiently as planned.

Zero-based budgeting may require an extensive amount of time, money, and paper work; but it does provide a systematic method of addressing an organization’s financial concerns, in turn enabling an organization to better allocate its resources. A combination of zero-based budgets with rolling budgets or some other form of budgeting that spreads the work of justifying new budgets each cycle is one way to incorporate zero-based budgeting without undo stress at the same time for all managers with budgetary responsibility. www. eferenceforbusiness. com/… /Zero-Based-Budgeting. html http The zero-based budgeting system puts the burden of proof on the manager, and demands that each manager justify the entire budget in detail and prove why he or she should spend the organization’s money in the manner proposed. A “decision package” must be developed by each manager for every project or activity, which includes an analysis of cost, purpose, alternative courses of action, measures of performance, consequences of not performing the activity, and the benefits.

This approach is different than traditional budgeting techniques due to the analysis of alternatives. Managers must identify alternative methods of performing each activity first, such as evaluating the costs and benefits of making a project or outsourcing it, or centralizing versus decentralizing operations. In addition, managers must identify different levels for performing each alternative method of the proposed activity.

This means establishing a minimum level of spending, often 75 percent of the current operating level, and then developing separate decision packages that include the costs and benefits of additional levels of spending for that particular activity. The different levels allow managers to consider and evaluate a level of spending lower than the current operating level, giving decision-makers the choice of eliminating an activity or the ability to choose from a selection of levels of effort including tradeoffs and shifts in expenditure levels among organizational units.

The decision packages must be ranked in order of importance once they have been created. This allows each manager to identify priorities, combine decision packages for old and new projects into one ranking, and allows top management to evaluate and compare the needs of individual units or divisions to make funding allocations. In this respect, zero-based budgeting is quite different than traditional rolling budgets. Rolling budgets often appeal to people who prepare budgets because they make budget development much easier.

Managers can add an inflation factor to the previous year’s budget and then include any adjustments for major changes. Rolling budgets also give management a concrete number to help make comparisons from year to year. However, traditional rolling budgets have a tendency to create conflict; they can create an incentive to spend money carelessly in order to justify the next year’s budget. They can also create inefficient operations due to the fact that individual departments or units do not have to justify expenditures based on operations, but only on the prior year’s expenditures.

Zero-based budgeting addresses such problems that can occur with traditional rolling budgets. In zero-based budgeting, each dollar spent by management must be justified with a detailed account of what will be purchased, how many labor hours are needed, what problems will be faced, and so forth. This allows management an opportunity to review operations in depth and make recommendations for changes to if necessary.

The zero-based budgeting process helps managers identify redundancies and duplications among different departments, concentrating on the dollars needed for proposed programs as opposed to percentage increases or decreases form the previous year. Specific priorities of departments and divisions are identified more easily in zero-based budgeting. The process also allows for the comparability of different departments as to the respective priorities funded. Zero-base budgeting enables a performance audit to determine whether each project or activity has been performed as efficiently as planned. ://www. referenceforbusiness. com/index. html.

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