Definition: Zero-based budgeting (ZBB) is a systematic cost management process which emphasizes on efficient allocation of the income to the fixed expenses, variable expenses and savings; such that the difference between income and expenditure nullifies. The purpose here is to eradicate extraneous business expenses.
It can be practised at regular intervals, some prefer to prepare a monthly zero-based budget; however, others carry it out quarterly or annually.
Content: Zero-Based Budgeting (ZBB)
For a detailed analysis of what actually a zero-based budget is, we must understand its presentation on a worksheet.
Zero-Based Budget Template
Let us have a look at the format used for zero-based budget practice in business organizations:
Zero-Based Budgeting Example
ABC Ltd. is a sanitizer manufacturing company. While going through the various expense; the manager felt the need for making the following changes to improve efficiency:
- One of the landline connections active in the under-construction floor is unnecessarily increasing the expense. Temporarily disconnecting the number can reduce the telephone bill up to Rs. 14400 per annum.
- The company can modify the production unit’s lighting by replacing the CFL lights with the LED ones to limit the electricity expense to Rs. Rs. 78000 per annum.
- One junior staff can be promoted to a superior position so as to replace an inefficient employee. This termination and promotion can bring down the salary expense up to Rs. 320000 per annum.
- A wasteful expense is made on travelling expense of the marketing executive who went to faraway places on his personal vehicle, for which the company paid for fuel. Travelling by bus would deteriorate this cost from Rs. 10000 to Rs. 8000 per annum.
- For the maintenance and repair of the machinery, the parts to be replaced can be directly bought at a discounted price from the spare parts company bringing this cost to Rs. 4500 from Rs. 5000.
- Some stationery products like registers and stamp pads are purchased in excess every year while they are already in stock. Thus, not buying such office supplies this year would reduce the expense by Rs. 600.
- The advertising expense has incremented to Rs. 7200 as the company extend such activities into new potential markets.
Given below is the Trading and P&L Account of ABC Ltd. as on March 31, 2020:
Using the given information, prepare the zero-based budget of ABC Ltd. for the financial year 2019-20.
Please note that the balance is considered to be emergency fund or savings.
Following is the zero-based budget of ABC Ltd. for the financial year 2019-20:
Zero-Based Budgeting Process
How do we go about zero-based budgeting?
This budgeting strategy has proved to be fruitful for individuals as well as business organizations.
It acts as a blueprint for some of the major budgetary decisions.
Given below are the five essential steps under this process:
Step 1: Establishing Goal
To start with zero-based budgeting, we have to ascertain a purpose or objective for which it is to be done. This goal is bounded with a time frame, whether it can be quarterly or yearly; and even monthly in some cases.
Step 2: Developing Means
Next, the ways to achieve the set targets are thought of and discussions are carried out on the most prominent ones. These can be activities which support task accomplishment for realizing the major organizational purpose.
Step 3: Figuring Out Solutions
Now, we have to determine the hurdles coming along the way of task accomplishment. Together with it, the multiple alternatives or solutions are analyzed and the most realistic ones are selected out of these.
Step 4: Finding Alternative Sources of Fund
Then comes the arranging of financial resources to fulfil the objectives. For this purpose, various possible sources of acquiring the required amount, at a sensible price.
Step 5: Setting Priorities
Lastly, fund allocation is done for which the priority expenses are listed. Accordingly, the least important obligations are set aside and the major ones are paid for.
Advantages of Zero-Based Budgeting
A zero-based budget is a thoughtful process where the managers can review their fund allocation decisions and wisely make the revisions.
Following are some of the major pros of preparing a zero-based budget:
- Brings Efficiency: Zero-based budgeting facilitates the optimum resource allocation. Since it depends upon realistic data rather than considering the historical figures for evaluation.
- Handles Budget Inflation: The managers can control the excessive cost by eliminating the unnecessary expenses, thus possibly filling the gaps of incremental budgeting.
- Better Coordination: It is a combined effort of all the organizational departments and managers. The accurate inputs and combined decision-making establishes excellent coordination among the personnel.
- Streamlines Actions: By budgeting, the managers can identify wasteful activities and more efficient methods of carrying out productive business operations.
- Cost Awareness: The managers can reassess the cash flow and thereby ascertain the operating expenses essential for obtaining superior results.
- Strategic Management: ZBB is all about preparing and effectively managing the income and expenditure in advance. Thus, it is a strategic action towards achieving the desired business goals.
- Generates Profit: It helps the organization to efficiently turn the business investment into returns. Thus, making more profit through cost-cutting and wise fund allocation is the primary motive of ZBB.
Disadvantages of Zero-Based Budgeting
Certainly, a zero-based budget is useful to everyone whether a small enterprise or a large business organization for strategic decision making.
Although, there are multiple shortcomings of the zero-based budgeting as discussed below:
- Lack of Expertise: Zero-based budget preparation is a complex task which requires managers with high-level skills and analytical ability.
- Adverse Effect on Brand: A rigorously practised zero-based budgeting may result in compromising with the company’s brand image if the managers consider cost over quality.
- Poor Organizational Culture and Standards: It may even spoil the quality and performance of the manpower if they start prioritizing cost over customer service; ultimately deteriorating the organizational standards.
- Time Consuming: ZBB is a lengthy process since it demands data collection and analysis. Thus, managers find incremental budgeting more convenient when it comes to periodic analysis.
- Irregular Expenses: It is quite challenging to figure out the sudden or occasional expenses accurately while preparing a zero-based budget.
- Require Manpower: When the organization newly adopts ZBB, it needs a whole group of personnel from different departments of the organization which is indeed an expensive deal.
Zero-based budgeting as we know is a strategic means of reviewing the unnecessary expenses which are being incurred in the organization.
However, some people believe that ZBB can work independently to deal with operational cost inflation. But its not so.
Zero-based budgeting can provide desired results only when together applied with other cost management strategies such as unit costing, process costing, batch costing, etc.