In this blogpost, Vernita Jain, Student, National Law Institute University, Bhopal, writes about what is zero-based budgeting, the process, advantages and disadvantages of zero-based budgeting.
ZBB is a process by a company prepares its budget to ensure more efficiency of the budgeting programme.
This process is different from traditional budgeting, as in this kind of budgeting a company starts preparing its budget from the scratch. In ZBB, a company examines all its expenditure and plans all the funding and radically redesign the budget based on its competitiveness and cost structures. Every year, in the beginning, the company forms a new budget and reviews every programme which does not include any previously authorized funds.
This type of process requires the managers to provide explanations of all the expenditures, from the preceding year. Thus, it is assumed that a manager has an expenditure baseline of zero.
The basic process flow under zero-base budgeting is:
- Identifying the objectives of the business.
- Creating and evaluating alternative methods in order to complete each objective.
- Evaluating the alternative funding levels, that depends upon the planned levels.
- Setting up the priorities in order to confirm to such budget and to increase efficiency.
ZBB offers appealing possibilities for reducing costs while bringing additional value in the form of operational efficiency. The potential impact can be especially pronounced in the public sector, if with the help of ZBB, government forms an accurate budget and funding, then if any additional funding that is received can be utilized effectively and efficiently.
Additionally, ZBB by giving importance to each program and forcing the stakeholders to work in order to fulfil each and every objective that is fulfilled increases efficiency. These force the centres to identify their goals. Furthermore, this increases transparency, both internally and externally by creating a budget and baseline from zero
The private sector can benefit in the same ways. It helps in thinking conventionally and allocating resources by providing an explanation to each funding and prioritizing each.
The biggest examples of ZBB presently are the private equity firm 3G and AB InBev and Heinz. 3G has been announcing large deals as well as the aggressive use of ZBB.
Advantages of ZBB
- Alternatives analysis. This process ensures that due to the force that is put on the managers to complete the objectives, they find alternate ways to perform each activity.
- Communication. This process could spark a significant debate among the management team about the corporate mission and how it is to be achieved.
- Eliminate non-key activities. It makes the managers examine those activities that are critical to the company. This enables them to target activities that are not beneficial for the company and eliminate them
- Mission focus. This forces the managers to focus on various objectives that are not given much importance.
- Redundancy identification. It may help to eliminate those activities that are being conducted in multiple departments.
- Required review. Using zero-base budgeting on a regular basis makes it more likely that all aspects of a company will be examined periodically.
- Resource allocation. If the process is conducted with the overall corporate mission and objectives in mind, an organization should end up with the strong targeting of funds in those areas where they are most needed.
Challenges and Risks
It can be very challenging for an organisation to complete a full ZBB cycle. The practice of the prioritizing program can be threatening to some managers and a source of the problem for departments with intangible outputs.
The drawbacks are
Bureaucracy: A large extent of training, examining and learning renders for completing the process of ZBB and requires additional staff.
Intangible justifications:. The areas with results that are not concrete and tangible in nature must be difficult to determine. It will be difficult to determine the exact amount of expenditure in the research and development activities.
Managerial time: The operational review mandated by zero-base budgeting requires a significant amount of management time.
Training: For the public sector in particular, it can be difficult to examine all of an organization’s programs within the limited time. The use of ZBB requires much training and the time required keeps on increasing each year.
Update speed: The budget based on the ZBB process is less likely to be continuous as it requires too many efforts.
Assessing Suitability: The process of ZBB in the public sector requires a small amount of savings in order to fulfil the complete process. They would also require sources to invest in the process. It may sometimes happen that, some of the organisations have money initially to start the process, but later on they may find it difficult to carry on with such a process as such a process might result in a risk of low investments.
The influence from the political parties and government officials render it difficult to conduct personal reductions, problems like this make the usage to the process of ZBB a little difficult.
The adoption of ZBB by the smaller agencies and NPO’s is most practical and common, as it helps them to examine their limited resources and work towards their specific outcomes. It seems unlikely that the government companies would benefit from ZBB process as such the process results in decreasing amount of returns as compared to the saving in the initial years.
This process of ZBB is beneficial for the private sectors as private companies do not face any restrictions compared to the government policies. But it is not necessary that if one process worked for one corporation than same can be beneficial for others too. Private corporations are likely to have a good amount of money which is required to be put at the initial stage of such process. The process of ZBB was successful in the case of these companies as it helped those increasing profits. The main reason that this process worked in the case of private companies is that private companies have human resources, cost, and training that is required for this process.
Even though there are so many challenges to such process, both the government agencies and private organisations adopt certain measures.
The private companies can make a team containing advisors, consultants etc. which is specialized in the process of ZBB. In the case of government agency too, they can establish a team to review the programme on a regular basis.
Another way governmental organisations and private corporations can work is by applying ZBB irregularly or only in selective departments; this could benefit those departments who are suffering from certain finance or resource problem.
ZBB process is not cost effective in the case of many organisations. However, this process can turn out to be beneficial for some. For those who don’t see the benefit in ZBB, they have many other alternatives that are less costly and less time consuming. For example, organizations can examine alternative activities, methods, and technologies that may be less costly focus more on the underlying cost drivers and are more effective at enabling strategy. Organizational needs rarely merit a full ZBB exercise and improvement can be made without going to extremes.