Zero based budgeting is a method of budgeting which begins every period on a clean slate thus, “zero base.”
This type of budgeting technique means that each function within the organization is analyzed in order to determine to its needs and costs. In addition, it does not matter whether the budget is lower or higher than the previous budget. What is important is that the budget is created on the basis of needs for the period budgeted for.
Truthfully, this type of budgeting technique is quite spine-chilling for many finance departments. Imagine having to create the budget from scratch every single time! That sounds terrible for any budgeter.
It is worth mentioning that this budgeting technique gained popularity after the financial crisis in 2008. Companies needed a way to allocate budgets based on efficiency and necessity.
During the recession period, cash flow was heavily guarded which was why budgeters had to review every program and justify every single expense which, of course, made a lot of sense at that time.
Budgeters can implement zero based budgeting to any form of cost: general and administrative costs, operating expenses, capital expenditures, variable distribution, marketing costs or cost of goods sold.
The Good, The Bad, and The Ugly
As the title suggests, zero-based budgeting technique is not for everyone.
In order to understand why this is the case, it is worth examining what the advantages and the disadvantages are for this type of budgeting approach.
Zero-based budgeting can be appealing because it offers the possibility of cost reduction while enhancing operational efficiency. This can be greatly appreciated in the public sector where payments are only made for efficient and justified programs.
This can even benefit certain private sectors because many companies will have to change the way they think and allocate. Private sectors that choose to use this budgeting technique will have to challenge every line item and assumption. This, in the best case scenario, leads to significant corporate savings for the company.
Other known advantages of zero-based budgeting technique are: alignment of budget to strategy, improved collaboration within the organization, and 10-25% cost reduction.
On the other side of the fence, this type of budgeting technique is not without criticisms, challenges, and risks.
Zero-based budgeting is not only costly, it is very time consuming because of the fact budgets have to be made from scratch every time! It is without a doubt that its execution can be time and again challenged because of the time needed to complete the cycle.
It can even be very cost prohibitive which can hinder growth and staff-wise, it requires special training and increase in personnel headcount. Something that is counterproductive to the goal of cost reduction.
This goes without saying – it can be possible, of course, to just cherry pick certain aspects of zero-based budgeting so that it can benefit certain parts of the organization immediately which in the end results to the budgeting technique being more similar to traditional budgeting than it is to zero-based budgeting.
Alternative Budgeting Techniques
It is no secret that the global economy is highly volatile today but despite a few companies reigniting interest in zero-based budgeting, it is our position that zero-based budgeting is still not the way forward. Not at this point at least.
It is too complex, time consuming, and impractical that many organizations are better off using alternative budgeting techniques.
There are Corporate Performance Management solutions out in the market like Performance Canvas by DSPanel that pushes for driver-based budgeting in order to attain the same goals of enhancing operational efficiency and cost reduction without necessarily increasing cycle time, headcount or requiring specialized staff training.
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