What is Zero-Based Budgeting? Meaning, Benefits and Process

Raghvendra Sonker

13 Sep, 2022

All types of businesses prepare a budget for adequate allocation of funds and effectively manage the cost of expenses. Due to the Covid-19 pandemic, businesses have suffered a significant loss and are looking for solutions to mitigate the losses. While presenting Budget 2021-2022, the finance minister mentioned the role of zero-based budgeting (particularly zero budget farming) and more resilient budgeting models to avoid unnecessary expenditure and restart the growth cycle and profitability.

What is Zero-Based Budgeting?

Zero Based Budgeting entails the preparation of a budget without any past references. The zero-Based Budget process is different from a traditional budgeting system (incremental budgeting system) in the way that the former budget is constructed fresh for each budget period starting from the base zero. In contrast, traditional budgets are based on the forecasts and allocated funding of the previous year’s budget template.

In zero-based budgeting, the existing business activities are critically analysed and examined along with newly proposed activities and justify each line item before allocating the fundsin the budget. Hence, this budget understands the actual needs of the business and disallows unnecessary credits for fancy endeavours.

Features of Zero-Based Budgeting

The features of Zero based budget are discussed below:

• No connection with the previous budget; start from scratch;
• Planned Spending;
• Strategic  Resource Allocation;
• Decreasing Strategic Goal Mismatch;
• Limiting communication failure across multiple business units.

Process of Zero-Based Budgeting

Zero-based budgeting can be prepared using different methods and unique approaches; some of the steps involved in creating zero based budget are discussed.

Identify the Business Plan

The foremost step for zero based budgeting is to identify the goals and objectives of the company.A new annual budget and structured operating plan are prepared from scratch without using the previous year’s actuals as a baseline.

Budget Evaluation

A systematic study of all the budget components has to be called to determine the scope for saving and cutting unnecessary expenses. Under the evaluation, a priority is given to comprehensive packages of items and ranked as per the needs of the business. Special emphasis is given to the cost-effective and cost-saving areas in zero based budgeting.

Alternate Working Methods

A company introducing the zero-based budget approach has to curb the multiple bottlenecks present in the organisation and look for alternate and efficient methods for achieving the current targets. 

Prioritisation of Activities

Some business activities need regular cost reduction and have to be separated and prioritised.A framework shall be put in place for performing all the determined activities in time bound manner to realise the maximum outcome. Adopting artificial intelligence, automation, and standardised practice can be beneficial for managing finances in difficult times.

Finalise the Zero Based Budget

After the comprehensive planning and execution processes, the effective communication of specific roles and responsibilities to the employees and different business units of an organisation is required to complete the zero-based budgeting process.

Advantages

• It allows better monitoring of the company’s cash flows and stops unnecessary spending of funds which provides financial security;
• It minimises the redundant and unproductive activities of the organisation;
• Zero Based Budgeting provides an opportunity to customise the expenditure and handle it efficiently;
• Plan discretionary funding for the upcoming financial, regardless of the previous allocations in the budgets;
• Cost-benefit analysis^[1] are taken into consideration, whereas traditional budgeting involves studies of the changes in expenditures;
• Sometimes same activities are performed by numerous units; thus, zero-based budget evaluation helps remove the multiplicity of the operations;
• Organisations implementing zero-base budgeting regularly can identify and resolve the issues efficiently due to periodic assessment of each line item of the annual budget;
• Zero-base budgeting compels management to decide and select operations necessary for the organisation. It allows the elimination and outsourcing of non-essential activities.

Disadvantages

• The process of zero based budgeting is expensive, complex and time-consuming, as it takes a lot of time to closely analyse and justify each line item of the budget;
• Execution of the operations can be challenged due to high manpower requirements (limited finances and time);
• The involvement of different business units is required for ascertaining the specific needs of employees;
• This budget empowers managers to singlehandedly decide and allocate funds for spending;
• May harm the established brand and organisational culture;
• One of the major disadvantages of zero-based budgeting is that it is based on short-term planning, which includes the transfer of resources in the direction of the specific units which will generate profits over the completion of a financial period.

Conclusion

In recent years, large MNCs and private equity companies have started adopting zero-based budgeting as it generates space for cost minimisation and financial stability. The concept requires the training of employees to build cost-cutting culture.To summarise, zero based budgeting allows an efficient resource allocation with a cost reduction mechanism.

Read our Article: An overview of the 2022 Budget