Zero-based budgeting - what's so special? - F5/P5

Zero-based budgeting (ZBB) is a more modern type of budgetary system. In the past (and also current), many companies prepare budgets with an incremental budgeting system which takes last year figure and adjusts for changes in volumes or inflation. Such system is known to cause management to build in budgetary slack (overestimation of expenses or underestimation of revenues). ZBB solves this problem and requires management to prepare budgets from zero base, ie. a new beginning.

In ZBB, every item of expenditure has to be justified by the management first before it is allowed to be included in the budget. This means that management must have a good reason for the provision of certain expenses. Generally, ZBB involves three stages: Defining decision packages, ranking decision packages and allocating resource.

1. Define decision packages
Decision packages are plans. Firstly, management has to prepare a base decision package showing the minimum level of expenditure required to run the department/company/project. Incremental package can then be prepared which shows the extra expenditure that will be needed. Management will try to justify the incremental package so that it can be chosen as priority.

2. Ranking decision packages
After the senior management received all decision packages from each manager, he will rank the incremental decision packages based on the benefit to the organisation.

3. Allocating resource
The incremental decision packages that are chosen as priority will be given resources so that the management can do according to the decision packages. Those ranked as low priority may not be allocated resources. However, resources will be allocated to all base decision packages.

From the above, we can easily identify one obvious disadvantage, that is time-consuming. Preparing ZBB involves a significant amount of time and due to its complexity, management might have to be trained first. ZBB should not be implemented unless the benefit of implementing ZBB exceeds cost.