Zero Based Budgeting is a method of budgeting wherein no base is considered for any budget. Having learned Zero Based Budgeting in past, we shall, in this article discuss the Advantages and Disadvantages of Zero Based Budgeting.
Table of Contents
- 1 Zero Based Budgeting – Meaning
- 2 Advantages of Zero Based Budgeting
- 3 Disadvantages of Zero Based Budgeting
Zero Based Budgeting – Meaning
As the name indicates, zero-based budgeting is a budgeting method in which there is a zero base consideration while preparing the budget. It justifies all the expenses each time, we prepare a new budget. Zero-based budgeting does not aim to consider any base. Each expense has to be drilled down and analyzed well before the actual allocation of the budget. It is known as need analysis. The preparation of the budget is on the basis of actual need of the expenses for the forecasted period. It does not consider the fact that the previous budget was lower or higher than the current budget.
Zero-based budgeting targets to identify efficient and alternative methods for the organizations who opt for optimum utilization of resources. This will not only ensure efficiency and effectiveness but also wealth and profitability.
Any process will have advantages and disadvantages. However, we can call a process to be a feasible one only when its advantages exceed its disadvantages.
Advantages of Zero Based Budgeting
Emphasize on Decision Making
Traditional budgeting considers the fact that “how much” expense shall be incurred. However, zero-based budgeting is on “why” approach. It goes to the root of the expense. Zero-based budgeting aims towards achieving the objectives of the organization. For better decisions, Zero-based budgeting completely ignores the past years’ figures.
Orientation towards Cost-benefit Analysis
Zero-based budgeting aims at cost-benefit analysis. It does not focus on studying the changes in expenses and preparing a variance analysis (such as why the expenses increased or reduced). However, it considers the necessity of the expense and the benefit which will be derived from the expense. In order to prepare an effective zero-based budget, more and accurate information is a must. Zero-based budgeting operates vertically as well as horizontally. And hence it enables all the levels of management to participate in the decision-making process of the organization.
Efficiency in resource allocation
The ultimate objective of any organization is to maximize the profitability of the organization and enhancing the wealth of the shareholders. The zero-based budget helps in achieving this objective. Zero-based budgeting ensures that the resources of the organizations are economically and efficiently allocated.
Improvement for next period
For each year, the preparation of the zero-based budgeting is with the same assumption of not taking a base for any previous period. Each department of the organization analyzes the expenses every year. They make sure that there is an inclusion of only those expenses in ZBB which are necessary and which derive benefits.
Discontinuation of an obsolete process
At first, the zero-based budget identifies all the obsolete processes of the manufacturing unit or other departments of the organization. If the process is not essential for the organization, the same has to be analyzed and scrapped by the management. Discontinuation of obsolete operation results in better costing, better pricing and better profitability of the organization. Zero-based budgeting helps in enhancing the interpretation and knowledge of different cost patterns.
Changes with the change in an organization
Due to technological changes, with the new and advanced processes, the underlying assumptions and expenses have to be changed. Hence, zero-based budgeting responds to the changes in the organization.
Disadvantages of Zero Based Budgeting
Subjective in nature
Some of the expenses in the organization are difficult to judge whether the same is essential or not. The reason is the benefits are qualitative in nature and one cannot measure it in numbers.
Well, the organization can overcome this disadvantage by a thorough analysis of the expenses and with the help of management consultants.
Detrimental to the long-term goals
Zero-based budgeting is based on a cost and benefit analysis of a particular period. In the short run, the company may not get benefit in the same year of incurring the expenses. However, some of the expenses which have to be incurred for achieving the long-term goals of the organization.
The top management shall make a list of all the expense which has long-term benefits and exclude the same while preparing the budget.
The organization should not always stick to the budget in every situation. Sometimes circumstances may arise which lead the management to incur the expense of the unexpected opportunity or to mitigate the possible threat.
The company can make a provision of the same in zero-based budgeting and overcome the same.
Skills and managerial conflicts
Management conflicts may arise since the zero-based budgeting requires a large amount of time and efforts of the managerial and executive staff. Sometimes, the required skills are also not present in the staff for preparation of zero-based budgets.
The management shall make proper planning and involvement of qualified and experienced staff to participate in the zero-based budgeting process.1–3Last updated on : January 5th, 2019