Zero-based budgeting (ZBB) is a management tool used to control the costs in an organization. It is a budgeting method where current year’s budget is prepared from the scratch i.e. taking the base as zero. The old and the new activities of the business are ranked according to their importance. Based on the priority, the available resources are allocated to each activity without considering the past budgets or achievements. For creating a Zero Based Budget, a step-wise approach is followed. Let us understand the Steps in Zero Based Budgeting in detail.
Steps in Zero Based Budgeting
Identifying the Decision Units:
First and foremost step involved in the zero-based budgeting process is, identifying the decision unit. A decision unit can be a single activity or a cluster of activities which can be independently and meaningfully identified. By independent, we mean an activity which is isolated and not overlapping other activities. So every decision unit will be separate from each other. An organization is divided into many decision units. Each cost center like marketing department, production department, human resource department, research and development department, etc. acts as a decision unit. This step plays a significant role in justifying each item of expenditure in the budget. Manager of each decision unit has to give justification for the expenses and required budget allotment for his decision unit. The justification given by the manager should not be based on prior period budget or based on his decision unit’s expenditure in the preceding year. Since zero-based budgeting is preparing the budget from the scratch, therefore the justification for required budget should also be fresh.
Making Decision Packages:
In this step, the decision units that were identified in the first step are broken down into smaller decision packages. These decision packages must be in line with the objectives of the organization. Each decision package acts as a standalone proposal which is appealing for allocation of funds. Each decision package defines the functions, activities, and operations of the proposal, the need for the proposal, economic and intangible benefits associated with the implementation of the proposal, loss of opportunity if funds are not allocated to the proposal, etc. A formal decision package must contain the following information:
- The task for which the decision package is made
- Goals and objectives of broader decision unit of which it is part of
- Goals and objectives of the decision package
- Analyzing the need for the task
- Analyzing the technical and operational viability of the task
- Analyzing the alternative course of action
Ranking Decision Packages:
This is the third step involved in the zero-based budgeting process. In this step, all the decision packages within a decision unit and among various decision units are ranked in the order of their importance and priority. The logic behind prioritizing decision packages is to have an efficient allocation of scarce resources. Decision packages are ranked based on the cost-benefit analysis. While doing this, all the alternatives options are evaluated so as to select all the better and cost effective options. Top management reserves all the rights to approve or reject a decision package. Only those decision packages are approved which help the organization to achieve its predetermined objectives. Management also ensures that the costing in each decision package is accurate and realistic.
Allocating Available Resources:
This zero-based budgeting step an extension of the previous step. The decision packages that are ranked in the previous step are allocated funds in this step. So we can say that in this step funding decisions are made. The allocation of funds and other resources are based on the ranking of decision packages. So the most promising decision packages get better funding. This ensures optimum utilization of scarce resources.
Controlling and Monitoring:
This is the last step in preparing zero-based budgeting. In this step, decision packages are monitored and evaluated for their performance and output. Measuring the performance of the decision packages helps the management to understand whether the allocation of resources is done accurately or not.
Conclusion: Since zero-based budgeting is a cost control technique, it is very important that the steps to implement zero-based budgeting are properly and wisely followed. There must be a detailed description of how the allocated funds would be used by each department and how the organization will benefit from it overall. Though steps involved in zero-based budgeting process are time-consuming, it provides the most systematic method of allocation of company’s funds.
B. Saravana Prasath, Advanced Management Accounting, 7th Edition