Zero Based Vs. Incremental Budgeting

Zero-based budgeting and Incremental budgeting are the two most commonly used methods of budgeting that are implemented by most of the companies. Both the methods are unique and are different from each other in many ways. Before going through the differences, let us understand the meaning of zero-based budgeting and incremental budgeting in brief.

Zero-based budgeting 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 and based on that, resources are allocated to each activity without considering the past budgets or achievements.

Incremental budgeting is a budgeting method where current year’s budget is prepared by making changes in the past year’s budget. The changes are in the form of addition or reduction of expenses to last year’s budget.

Following points will highlight the differences between zero-based budgeting and incremental budgeting.

Zero Based Budgeting vs Incremental Budgeting

Base for Budgeting: Zero-based budgeting is done considering the base as zero i.e. it is done without considering the budget of the previous year. For every financial period, a fresh budget is prepared from the scratch and resources allocated to each department are justified according to the expenses of that particular period. On the other hand, incremental budgeting is different from zero-based budgeting. In case of incremental budgeting, current year’s budget is prepared by making changes in the budget of the previous year. In Incremental budgeting, the starting point for preparing budget is prior period’s budget. Taking this as base, current period’s budget is prepared.

Allocation of Resources: In zero-based budgeting, the budgets are prepared by allocating maximum resources to those activities which benefit the organization. The activities which are revenue generating and critical to the survival of the business, get the top most priority, Incremental budgeting is done without giving any priority to vital activities of the business and last year’s budget is simply adjusted considering the inflation factor.

Wasteful Expenses: Since zero-based budgeting is prepared from the scratch, any resource to an activity would be allocated only after considering the risk reward ratio and cost benefit analysis. This eliminates all sorts of inefficiencies that are present in an activity. Thus it avoids any wasteful expense. In the case of incremental budgeting, wasteful expenses become the part of the budget. The inefficiencies present in the activities are mostly ignored and only the increase in cost forms the part of incremental budget.

Innovation: Zero-based budgeting promotes innovation in the business. As budgets are prepared right from start for each period, it forces the management to come up with innovative ideas to lower their costs so that they can justify the allocation of resources. On the other hand, incremental budgeting leads the company into a conservative mindset. As the budgets are almost same over the years, it does not promote any innovation in the business.  Therefore, zero-based budgeting is dynamic in nature whereas incremental budgeting is conservative.

Time Consuming: Zero-based budgeting is a time consuming process mainly because the budget is prepared right from the start, which makes it a time consuming task. On the other hand, incremental budgeting is less time consuming method because they are prepared by taking previous year’s budget as base and changes are done in the previous year’s budget to meet the needs of current period.

Ease of Preparation: Zero-based budgeting requires justification for allocation of available resources, which can be known only after deep analysis and complex calculations. Thus, preparation of zero-based budgets is a complex task. Whereas, incremental budgets are easier to prepare as it does not involve any complex calculations and can be prepared by any department of the organization just by introducing the incremental changes.

Training: Managers require special skills and knowledge to prepare zero-based budgets. Only a qualified and well trained professional can prepare such budgets. On the other hand, incremental budgets are easy to prepare. They do not require any specialized knowledge or training to prepare the budget. Any department can make an incremental budget with ease.

References:

http://www.tutor2u.net/business/reference/budgeting-methods-incremental-budgeting

http://www.finweb.com/financial-planning/zero-based-budgeting-vs-incremental-budgeting.html#axzz4Pxw7jF7Y

http://www.investopedia.com/terms/z/zbb.asp

http://www.accountingtools.com/zero-based-budgeting

http://www.accountingtools.com/questions-and-answers/what-is-incremental-budgeting.html

http://www.mamaye.org/en/blog/budgeting-zero-vs-incremental-method

http://thefinancebase.com/zerosum-budgeting-1571.html

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