What is a Zero Based Budget?

A zero-based budget (ZBB) requires all expenses to be justified each period. Essentially, a zero based budget is when you create a budget from scratch each period. Each period, reevaluate and justify all expenses in terms of the company’s overall strategic objectives. Distinguish the zero-based budget from the traditional budget. Do not build a ZBB upon the previous period’s budget.

Traditional Budget

Often times, when creating a budget, the manager will simply start with the previous period’s budget and add to it. The previous period’s costs and expenses are considered inevitable for the current period. Based on proposed plans and projects the manager then adds costs to the budget for the upcoming period. Over time, when using this method, budgets can just grow period after period. By starting with the old budget and adding costs, the company does not justify or reexamine the previous period’s costs.

Zero-Based Budget

A zero-based budget basically requires starting from scratch each period. When preparing a ZBB, the previous period’s budget is all but ignored. At the beginning of the period, all cost-incurring activities must be examined and justified in terms of the company’s strategic objectives. Cut activities that aren’t necessary. Scrutinize necessary activities for opportunities to reduce expenses. Then continue essential activities as needed. Then build the budget around the remaining necessary activities.

Zero-Based Budget – Advantages

There are several advantages to using a zero-based budget. By severing the link with the previous period’s budget, you can avoid the gradual incremental increases that can accumulate period after period when budgets are prepared using the traditional method. You can also reevaluate and fund business activities according to merit and according to alignment with the organization’s strategic objectives. Preparing a budget with the zero-based budget method is an effective way to plan and an effective way to contain and control costs in an organization.

Zero-Based Budget – Disadvantages

Preparing a budget using the ZBB method can be costly. It requires a lot of time, effort, and commitment from employees. Preparing a zero-based budget requires much more time than preparing a traditional budget. Because of this, it may be optimal to prepare a ZBB every few fiscal periods as opposed to every fiscal period. Preparing a zero-based budget requires much more effort than preparing a traditional budget. It requires deeper analysis and scrutiny of all budget items.

See Also:
How to Estimate Expenses for and Annual Budget
Capital Budgeting Methods
LIFO vs FIFO
Chart of Accounts (COA)
Administration Expenses