Zero Base Budgeting: Meaning, Benefits, Limitations and Steps

Zero Base Budgeting (ZBB)

Meaning, Benefits and Limitations

Steps and Pre-Conditions

Zero Base Budgeting

Zero Base Budgeting is a new technique for the preparation of budgets. It involves fresh evaluation of every item of expenditure as if it were a new item. It is reconsideration of each item of expenditure from the very beginning. It is like assuming that a zero expenditure has been incurred on a project at the time of its review, although the project may be in existence from a long time and may have involved some expenditure also. The review is meant to provide a justification or otherwise of the project as a whole in the light of objectives set for it and priorities of the society. The procedure is altogether different from the usual procedure followed in India.

Peter A. Phyrr describes, the concept of zero base budgeting as an operating, planning and budgeting process that requires each manager to justify a budget request in detail from scratch…….” It means, the budget as a whole is considered rather than to examine incremental change only.

According to Prof. R. A. Musgrave, “the idea of zero base budgeting is to consider the budget as a whole, rather than to examine incremental changes only.”

Essentially, the concept of zero base budgeting is that all the financial requirements of a budget unit are analyzed, evaluated and justifies annually and not just the increased or additional requirements. In more practical way, zero base budgeting means the evaluation and prioritization of all programmes at different levels of effects. To be simpler, under zero base budgeting, each department ministry is required to justify its budget requests from the bottom up, evaluating alternative programme packages and ranking programmes so as to select the best alternative and allocate resources accordingly. The budget is considered as a whole and a fresh one, i.e. from zero base.

Benefits and Limitations of Zero Base Budgeting

Zero-base budgeting is revolutionary concept and is relatively a new management tool for planning and control of activities. It involves people at all levels in the organization and promotes team sprit. The plans and budgets based upon ZBB are much improved than shoes based upon traditional budgeting. There are a number of benefits that arise from zero-base budgeting. Some of the important advantages of ZBB are enumerated below:

1.       Proper Allocation of Funds: It enables management to allocate funds according to the jurisdictions of the programme. The priority can be fixed for various activities and their implementation will be in the same order.

2.       It improves Efficiency: Zero-base budgeting improves efficiency of the management. Every manager will have to justify the demand for resources. Only those activities will be undertaken which will have justification and will be essential for the business.

3.       Identification of Economical Areas: Zero-base budgeting will help in identifying economical and wasteful areas. Emphasis will be given to economical activities and alternative courses of action will also be studies.

4.       Optimum use of Resources: The management will be able to make optimum use of resources. The expenditures will be undertaken only when it will have justification. A list of priorities is prepared and cost-benefit analysis will be the guiding principle in fixing the priority.

5.       Determining of Utility: Zero-base budgeting will be appropriate for those areas whose output is not related to production. It becomes difficult to evaluate the performance of those sides which are not directly related to production but undertaken other activities. This technique will be helpful in determining the utility of each and every activity of the business.

6.       Useful of Attain organizational Goals: Budgeting will be related to organizational goals. Something will not be allowed the plea that it was done in the past. Only those things will be allowed which will help in realizing organizational goals.

7.       Job Satisfaction: ZBB ensures greater participation of personnel in formulation and ranking processes. This helps in promoting level of job satisfaction and thus resulting in better control and operational efficiency in the organisation. 

8.       Applied to priority areas: Zero base budgeting is a flexible tool that can be applied on a selective basis. It does not have to be applied throughout the entire organisation or even in all the service departments. Keeping in view the limitations of time, money and persons available to install, operate and monitor it the management thus can select priority areas to which zero base budgeting may be applied. 

LIMITATIONS OF ZERO BASE BUDGETING

In spite of many advantages, there are a number of limitations arising mainly from difficulties in operation of ZBB. Some of the important limitations are as below:

1)      Bureaucratic and Time Consuming: Though zero-based budgeting proved to be a useful budgeting process to review discretionary overheads but the process was so bureaucratic and time consuming that the organisations got discouraged to use it again. Moreover, like traditional budgeting, it was based on the organisational hierarchy. It thus reinforced functional barriers and failed to focus on the opportunities for improving business processes.

2)      Incorrect Assumptions: Although budgeting depends on many assumptions as a basis, organisations use the previous year’s assumption as a basis only. Each assumption has to be determined without looking at the previous year’s budget. If the assumptions are incorrect, then the budget will not be accurate and will be of little help to the organisation.

3)      Threat felt by bureaucrats: The major problem is the threat that many bureaucrats feel towards a process which evaluates the effectiveness of their programs.

4)      Lacking in Programs: For many programs, workload and performance measures may be lacking or the cause/effect and program impact may not be well defined so that the analysis will be less than perfect.

5)      Based on organisation hierarchy: Like traditional budgeting, it was based on the organisational hierarchy. It thus reinforces functional barriers and fails to focus on the opportunities for improving business processes.

6)      Too much paper work: A major reason for failure of ZBB has been too much of paper work involved in the process which was found unmanageable by the organisation concerned. Also, the reviews and analysis required to be carried out could not be handled within the normal cycle of the budget process spreads over a few months.

7)      Difficulties in ranking of decisions: Difficulties in formulation and ranking of decisions packages as every manager may not have been necessary expertise.

8)      No flexible budgeting: The system of zero base budgeting has no scope to adjust for the changes and thus, flexible budgeting is not possible. 

TRADITIONAL BUDGETING Vs. ZERO BASE BUDGETING

Basis	Traditional Budgeting	Zero-Base Budgeting
1. Emphasis	It is more accounting oriented than decision oriented. Depends upon past data and lays emphasis on ‘how much’.	It is decision oriented lays emphasis on ‘why’.
2. Approach	Its approach is monitoring toward expenditures.	Its approach is towards achievement of objectives.
3. Focus	Its focus is on increase or decrease in expenditure over the past.	Its focus is on cost benefit analysis.
4. Communication	In traditional budgeting communication is usually vertical.	It encourages communication both vertically and horizontally.
5. Method	The method preparation of the traditional budget is based upon extrapolation.	Its preparation is based upon selection of decision package in view of cost-benefit analysis.

Steps in Zero-Base Budgeting

a)      Objective: The objective of budgeting should be determined. When the objective is clear, then efforts will be made to achieve that objective. Different organizations may have different objectives. One concern may try to reduce the expenditure on staff, another may try to discontinue one project in preference to another. So the first step will decide about the object and then other steps will be possible.

b)      Decision for operation: The extent to which zero base budgeting is to be applied should be decided. Whether it should be used for all operational areas or it should be applied in some areas only should be decided beforehand.

c)       Decision Package: The next step in ZBB is developing of ‘decision packages’. A decision package is “a document that identifies a specific activity in such a manner that management can evaluate and rank it against other activities competing for limited resources, and decide whether to approve or disapprove it.”

d)      Cost and Benefit: Cost and benefit analysis should be undertaken. We should consider the cost involved and the likely benefits to accrue. Only those projects should be taken first where benefit is more as compared to the cost involved. Cost benefit analysis will help in fixing priority for various projects on the basis of their utility or ranking of decision packages. It provides answers to the following questions.

1.       Is it necessary to perform the activity at all? If the answer is in the negative, there is no need for proceeding further.

2.       How much is the actual cost and what is the actual benefit of the activity?

3.       What is the estimated cost and estimated benefit of the activity?

4.       If the unit is dropped, can the unit be replaced by outside agency?

e)      Preparation of budgets: The activities and projects for which benefit is more than the cost are ranked. Priority is accorded to the most profitable projects/activities, in the allocation of funds.

f)       Selection and Approval: The final step involved in zero-base budgeting is concerned with selecting, approving decisions packages and finalizing the budget.

PRE-CONDITIONS OF ZERO BASED BUDGETING (ZBB)

The introduction of Zero Base Budgeting (ZBB) is not as easy as it appears. It requires a tremendous paper-work and detailed analysis. Thus, the organization should be able to provide all information including the cost data necessary for introducing ZBB. Moreover, the successful implementation of the zero base budgeting also depends upon the availability acceptability of the concept in letter and spirit. Obviously, this acceptance would be associated with the organization where the new system has to be implemented. It is so because any apathy on the part of the people could lead to a situation in which priorities relating to the existing schemes may not be assessed accurately. In short, it requires the following pre-conditions:

1. Committed Management: The top management must be committed as well as have a participatory role.

2. Fixed goals: Organisational goals must be fixed. As ZBB is not an end product itself but a means to achieve targets, goal setting must not be vague and ambiguous.

3. Identification of weakness: Weakness of an organisation must be perceived and strengths enumerated so that identified weak areas can be worked upon.

4. Trained staff: ZBB requires staff to be trained for its procedures to be implemented properly.

5. Elimination of doubts: All levels of management must cooperate with each other by eliminating all doubts regarding the ZBB procedure.

6. Review: Decision packages must be reviewed periodically.

7. Brainstorming Session: There must be brainstorming sessions at all hierarchical levels to get proper and timely feedback.