Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. The process begins from a “zero base” and every function within an organization is analyzed for its needs and costs. The budgets are then built around what's needed for the upcoming period regardless of whether each budget is higher or lower than the last one.
Key Takeaways
Zero-based budgeting is a technique used by companies but this type of budgeting can be used by individuals and families as well.
Budgets are created around the monetary needs for each upcoming period such as a month or a year.
Traditional budgeting and zero-based budgeting are two methods used to track expenditures.
Zero-based budgeting helps managers lower costs for a company.
How Zero-Based Budgeting (ZBB) Works
ZBB allows top-level strategic goals to be implemented into the budgeting process by tying them to specific functional areas of the organization. Costs can then be first grouped and then measured against previous results and current expectations.
Zero-based budgeting can be a rolling process done over several years with a few functional areas reviewed by managers or group leaders at a time because of its detail-oriented nature. It can help lower costs by avoiding blanket increases or decreases to a prior period’s budget but it's a time-consuming process that takes much longer than traditional, cost-based budgeting.
The practice favors areas that achieve direct revenues or production because their contributions are more easily justifiablethan in departments such as client service and research and development.
Zero-based budgeting is primarily used in business but it can be used by individuals and families, too.
Zero-Based Budgeting vs. Traditional Budgeting
Traditional budgeting calls for incremental increases over previous budgets such as a 2% increase in spending. Zero-based budgeting requires a justification of both old and new expenses.
Traditional budgeting also only analyzes new expenditures. ZBB starts from zero and calls for a justification of old, recurring expenses in addition to new expenditures. Zero-based budgeting aims to put the onus on managers to justify expenses. It drives value for an organization by optimizing costs, not just revenue.
Suppose a construction equipment company implements a zero-based budgeting process calling for closer scrutiny of manufacturing department expenses. The company notices that the cost of certain parts used in its final products and outsourced to another manufacturer increases by 5% every year.
The company can manufacture those parts in-house using its workers. It finds after weighing the positives and negatives of in-house manufacturing that it can make the parts cheaper than the outside supplier.
The company can identifya situation in which it can decide to make the part itself or buy the part from the external supplier for its end products instead of blindly increasing the budget by a certain percentage and masking the cost increase,
Traditional budgeting may not allow cost drivers within departments to be identified but zero-based budgeting is a more granular process that aims to identify and justify expenditures. Zero-based budgeting is also more involved, however, so the costs of the process itself must be weighed against the savings it might identify.
What Is Zero-Based Budgeting?
Zero-based budgeting was created in the late 1960s by former Texas Instruments account manager Peter Pyhrr.
Zero-based budgeting starts at zero, unlike traditional budgeting. It justifies each expense for a reporting period.
Zero-based budgeting starts from scratch, analyzing each granular need of the company instead of using the incremental budgeting increases found in traditional budgeting. This essentially allows for a strategic, top-down approach to analyze the performance of a given project.
What Are the Advantages of Zero-Based Budgeting?
Zero-based budgeting offers several advantages, including focused operations, lower costs, budget flexibility, and strategic execution. The highest revenue-generating operations come into greater focus when managers think about how each dollar is spent. Lowered costs may result because zero-based budgeting may prevent the misallocation of resources that can happen over time when a budget grows incrementally.
What Are the Disadvantages of Zero-Based Budgeting?
Zero-based budgeting has several disadvantages. It's time- and resource-intensive. The time cost involved may not be worthwhile because a new budget is developed each period. Using a modified budget template instead may prove more beneficial.
ZBB may reward short-term perspectives in the company by allocating more resources to operations with the highest revenues. Areas such as research and development or those that have a long-term horizon, may be overlooked as a result.
The Bottom Line
Zero-based budgeting (ZBB) justifies all expenses for each new period. The process begins from a “zero base,” analyzing every function within an organization for its needs and costs. Budgets are then built around what's needed for the upcoming period regardless of whether each budget is higher or lower than the one before.
With a zero-based budget, you ensure your income minus your expenses equals zero. This way, every dollar you earn has a purpose and is accounted for. This strategy helps you manage your money to cover your living expenses and strive to improve your financial health. Let's say you earn $6,000 per month.
The zero-based budgeting process is a strategic budgeting approach that mandates a fresh evaluation of all expenses during each budgeting cycle. Unlike traditional budgeting, where previous spending levels are typically adjusted, ZBB requires individuals or organizations to justify every expense from the ground up.
What Is Zero-Based Budgeting (ZBB)? Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. The process begins from a “zero base” and every function within an organization is analyzed for its needs and costs.
2 List your expenses (including any money you'll save). 3 Subtract expenses from income to equal zero. This is called a zero-based budget, and it helps you give every dollar you made that month a clear purpose. 4 Track your spending to make sure you stick to your plan.
Instead of spending $10,000 in this example of zero-based budgeting, you only need to spend $3,000. You would mark $3,000 for advertisem*nts. And, you find out you can get a better rate from a different office supplier, saving you $500. Instead of $1,500, your supplies will now only cost you $1,000.
To be a zero-based budget, your total outflow must equal your inflow. A zero-based budget can change month to month, or as often as you need. But it does require you to track your spending — whether by hand or with an app — to make sure you don't spend more than you have.
Zero-Based Costing is a strategic cost management approach where costs are analyzed and justified from a "zero base" without considering historical expenditures. Zero-Based Cost of a manufactured product consists of item wise detailed cost of raw material, manufacturing process, tooling and overheads.
The foremost theoretical advantage of ZBB is that it offers a rational and comprehensive means to cut the budget. ZBB can be used to make different cuts to different services based on the perceived value to the organization (rational) and all spending is put under scrutiny (comprehensive).
Zero-based budgeting (ZBB) is a budgeting technique in which all expenses must be justified for a new period or year starting from zero, versus starting with the previous budget and adjusting it as needed.
If you struggle with keeping track of your monthly expenses and haven't tried any kind of budget before, the zero-sum approach could help you get some clarity on where your money is going—which, in turn, can help you be more purposeful with how you spend.
The biggest advantage of zero-based budgeting is that it forces you to be intentional about your spending. Rather than have a large sum of money available to spend each money, you can only spend money that you've actually budgeted for that purpose.
It means putting 20% of your income toward savings and 80% toward everything else. Paying yourself first can be effective because it ensures you save something every pay period, and it reduces the chance that you'll spend money you intended to save.
Key Takeaways. The 50-30-20 budget rule states that you should spend up to 50% of your after-tax income on needs and obligations that you must have or must do. The remaining half should dedicate 20% to savings, leaving 30% to be spent on things you want but don't necessarily need.
Introduction: My name is Melvina Ondricka, I am a helpful, fancy, friendly, innocent, outstanding, courageous, thoughtful person who loves writing and wants to share my knowledge and understanding with you.
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