ZERO BASE BUDGETING (ZBB) – AN OVERVIEW:
The use of zero base budgeting has become an important managerial tool since 1970’s. It has been widely accepted in the business world as it greatly helps in integrating managerial functions of planning and controlling
Conventional budgets are generally prepared on the basis of past performances and actual costs. They are developed on the concept of incrementalism. Under this concept, the cost levels of previous years are often taken as a base to start with and focus their attention on ascertaining changes that are required to make as compared to the previous year. As the previous year figures are taken as a base for the development of budget, it also carries forward previous year’s inefficiencies and extravagances.
Zero Base Budgeting, on the other hand is not based on such concept of taking previous year’s figures as a base rather it takes zero as a base. Taking zero as a base, the budget is developed by taking into account the activities likely to happen in the future period. Hence the past mistakes are not repeated.
Zero-base budgeting has been defined by its originator Peter A Pyher as follows:
“A planning and budgeting process which requires each manager to justify his entire budget request in detail from scratch (hence zero base) and shifts the burden of proof to each manager to justify why he should spend any money at all. The approach requires that all activities be analyzed in ‘decision packages’ which are evaluated by systematic analysis and ranked in order of importance.”
STEPS IN ZERO BASE BUDGETING:
The following important steps are followed while preparing a zero base budget:
- Ranking of decision packages: The management can evaluate such a decision package and rank it against other activities of an organization. The management can decide whether the decision package is to be approved or not.
- Identification of decision units: In this various decisions unit are identified in order to justify each and every expenditure item in their proposed budget.
- Preparing decision packages: Each separate activity of an organization is identified and designated as a decision package.
- Allotment of funds: Funds are allocated on the basis of above results by adopting a pyramid ranking system to ensure efficient allocation.
ADVANTAGES OF ZERO BASE BUDGETING:
The concept of zero base budgeting (ZBB) has the following merits or applications:
- Optimum Allocation of Resources: ZBB takes into account both the current as well as the future expenditures and place them in order of their priority. Funds being used on priority basis ensure that there will be effective utilization of resources.
- Better coordination: ZBB involves the planning and decision making process right from the scrap. It requires that all the units of organization to be well coordinated and hence the communication channels are also strengthened.
- Appropriate for non-manufacturing overheads: As the input of areas such as staff or other support areas cannot be directly related to final output. This method is said to be appropriate for these areas of an enterprise.
- Does not carry past inefficiencies: As the budgeting decisions are made not on the past figures but planning is done from the scratch or zero, the past inefficiencies or extravagances are not repeated.
- Cost conscious: Managers become very conscious on identifying priorities and allocating funds on the activities that enhances the overall profitability of the organization.
- Motivational impact: It motivates the management executives at all levels to actively participate in budgeting process.
DEMERITS OF ZERO BASED BUDGETING:
Along with having a number of advantages, it also has the following demerits:
- Give rise to conflicts: The process of identifying decision packages and ranking them on the basis of priority is quite complicated and may give rise to conflicts within the organization.
- Expensive: When it comes to large organizations involving vast number of activities, preparing different packages for different decisions can be costly.
- Does not consider the qualitative aspects: Some activities have qualitative impact rather than quantitative such as research & development.
- More burden & paper work: Preparing a large number of decision packages will increase the burden on managers and the paper work will also be increased.
Bottom line: In-spite of all such defects, it has been extensively adopted by governments all over the world and is more effective in controlling service department’s cost.