Zero Based Vs. Traditional Budgeting

Zero-Based budgeting and traditional budgeting are the two predominantly used budgeting techniques. These techniques help the companies to allocate capital to different departments.  These methods of budgeting vary from each other in many aspects viz. justification of data, base of budgeting, ease in modification of budget components, time required, allocation of resources, ease of preparation and training, etc.

Both the methods have their own advantages and disadvantages. , So companies need to wisely choose the preferred method choice, depending on what they desire to achieve through the budgeting process. Before going through the difference between zero-based budgeting and traditional budgeting, let us understand their meaning of 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.

Traditional budgeting is a method of preparation of the budget in which the last year’s budget is taken as the base. Current year’s budget is prepared by making changes to previous year’s budget by adjusting the expenses based on the inflation rate, consumer demand, market situation etc. While preparing the traditional budgets the past year’s revenues and costs form an integral part of current year budget, as current year’s budget is prepared by taking them as the base.

zero-based-vs-traditional-budgeting

Zero Based Vs. Traditional Budgeting

Following points will highlight the points of difference between zero-based budgeting and traditional budgeting.

Justification of Data: Zero-based budgeting is done taking the base as zero, as if there is no past or historic data. Here all the items in the cash flow need to be justified. So a new expense or income, as well as an old expense or income, requires a justification. While preparing the traditional budgets, only the items which are over and above the last year’s budget need to be justified. So, only incremental changes require an explanation, not everything else.

Base for Budgeting: Zero-based budgeting is done considering the base as zero (without considering the budget of the previous year). For every financial period, a fresh budget is prepared from the scratch. On the other hand, traditional budgeting uses previous year’s budget as a baseline to make current year’s budget. So the main stress lies on the previous level of expenditure.

Ease in Modification of Budget Components: In case of zero-based budgeting, it is easy to eliminate an existing item or add a new item to the current budget, as zero-based budgeting is a creation of entirely new budget from the ground. In other words, zero-based budgeting is more flexible in nature. Same is not the case with traditional budgeting. In traditional budgeting, it is difficult to modify budget components. Moreover, every year’s budget components are not exactly same. Budget components change depending on the market conditions and company’s objectives. Since traditional budgeting depends on preceding year’s budget, it is not necessary that the company uses same budget components as it used in preceding years budget. Hence it is very difficult to modify or eliminate an existing item or add a new item in the current budget. In other words, traditional budgeting is comparatively rigid in nature.

Time Required: One of the biggest problems with zero-based budgeting is that it is a time-consuming process as the budget is prepared right from the start. Any project, before being added to the budget, goes through a lot of comparisons and approvals which lead to spending excessive time on each project. On the other hand, traditional budgeting is less time consuming. Since changes are done in the previous year’s budget to meet the needs of the current period, half the work is already done before the budget process starts and only incremental changes are required.

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. So with zero-based budgeting the management can focus on priority decisions. Traditional 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.

Ease of Preparation and Training: Zero-based budgeting requires justification for allocation of available resources, which can be known only after deep analysis and complex calculations. Managers require special skills and knowledge to prepare zero-based budgets. Only a qualified and well trained professional can prepare such budgets. Thus, preparation of zero-based budgets is a complex task. Whereas, traditional budgets are fairly easier to prepare as they do not involve complex calculations.

References:

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

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

http://www.ukessays.co.uk/essays/finance/formal-and-traditional-budgeting.php

http://budgeting.thenest.com/define-traditional-budgeting-24338.html

http://www.fool.com/knowledge-center/how-zero-based-budgeting-differs-from-traditional.aspx

http://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f5/technical-articles/comparing-budgeting-techniques.html

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