Zero-based budgeting is a method that works with proper explanation of budget for all slots, so that you know whether what you’re spending on is necessary or not. You start with a ‘zero base’ for an organization and then you figure out the costs or requirements for every function. The final budget is then created keeping in consideration what will be needed in the upcoming time and whether the budget needs to be high or low. Zero budgeting gives you the facility of using a smart strategy. The costs are first put into groups and then compared to previous results, along with your current expectations. This gives you a clear idea of what was spent, what is being spent, and what will be needed to be spent.
However, zero-based budgeting can sometimes be a hassle, as it requires a lot of details. Due to that reason, it may take quite a large amount of time for it to be reviewed by the heads or managers. On the brighter side, zero-based budgeting is very useful if you want to lower your expenses, as it lowers the total cost by avoiding increases in the budget of a period. Need more information on what is a zero-based budget? Look no more, for all you need to know about a zero-based budget is right here.
Traditional Budget VS. Zero-Based Budget:
If we compare traditional budgeting and zero-based budgeting, traditional budgeting increases the budget by 2% from what it was in the previous period. In comparison, zero-based budgeting asks for justification for an increase or decrease in the budget, so that you can be sure about it where you are putting your money. Traditional budgeting looks at the new expenses only while zero-based budgeting begins from zero.
One thing to keep in mind is that zero budgeting does require a lot of time. If you compare it to traditional methods of budgeting, zero-based budgeting is a lot more time-consuming. Zero budgeting is comparatively more useful for businesses that are producing an item than businesses that provide services. The reason behind this is that costs for production businesses are more easily identifiable.
Steps To Create A Zero Budget:
#1 Identify the task.
#2 Figure out ways through which the task can be completed.
#3 Evaluate all the methods you come up with.
#4 Look for an alternative source of funds.
#5 Keep your priorities straight.
Firstly, you need to identify the task you’ll be working on. It can be a single task or a cluster of various tasks. If it’s for an organization, each department would have to perform certain steps that include identifying decision units, making and ranking decision packages, allocating available resources, and monitoring the entire task. The manager of each department would have to come up with justifications for each expense that they state for a certain task.
Advantages Of Zero-Based Budgeting:
When compared with other budgeting methods that do not require certain changes to be made to the time period, zero-based budgeting seems to be more accurate. It forces every department to look into what is flowing in and what is flowing out of the organization which helps in giving a better picture of the organization’s performance.
With this budget method, resources for each department are allocated wisely and efficiently. It does not only look at the numbers used in the past but also keeps in mind the actual numbers required and being used.
#3 Reduction In Redundant Activities:
Zero-based budgeting helps in recognizing what is needed by the organization and what is not. This helps the managers or heads understand what activity, object, or person needs to be removed as it is no longer productive for the organization.
#4 Budget Inflation:
A huge disadvantage of incremental budgeting is budget inflation which is overcome by zero-based budgeting as everything needs to be justified under it.
#5 Better Coordination And Communication:
As everything is justified and clear under a zero-based budget, it removes any doubts between employers so it becomes easier to communicate. This also leads to better and effective decision-making while motivating the employees by making them more involved.
Although there are a lot of advantages to zero-based budgeting, we cannot overlook the disadvantages it carries.
Disadvantages Of Zero-Based Budgeting:
#1 Time Consuming:
It can be very stressful for companies that are low on time, or for government-funded entities. In this case, incremental budgeting does not demand much time and maybe easier as compared to zero-based budgeting.
#2 More Manpower Required:
The entire budget making starts off from zero, meaning more effort from humans is required. This inevitably means that you would have to hire more employees in order to make the entire budget. This can be a problem as some departments do not have sufficient time or human resources.
#3 Lack Of Expertise:
The manager or head would have to be trained and educated specifically in this area, as it can be quite tricky to explain every single expense to form a proper budget.
Fundamentals Of Zero-Based Budgeting:
#1 A new year’s budget should never be connected with the previous year. This helps prevent any extra costs and make sure the amount being spent is based on the requirements and not historical idols. Moreover, it requires more effort and time as compared to budgeting plans that only take into consideration the history of spending
#2 Cuts are put all over the budget as they help in stopping underperformance and help in improving the allocation of spending.
#3 Budgets are restricted to certain activities and levels of service. This practice helps in increasing the data and knowledge of each department. It also encourages the behavior of doing the required actions with the right amount. Moreover, it associates expenditures with a requirement to make sure whether it’s necessary or not.
#4 The amount being spent should be matched with the corporate strategy as this helps in achieving the departmental goals and the general goals of the organization. However, prioritizing activities in certain ways can be difficult.
Best Zero-Based Budgeting Practices
#1 Pursue A Positive Approach:
Zero-based budgeting makes it essential to free any resources or funds that are needed by the company in order for it to grow. You would have to make use of both internal and external approaches to identify why there has been a gap in profits. If there are any savings you should decide on a conclusion about what can be done with them so that they prove to be most beneficial for the organization.
#2 Recognize The Quick Targets:
Zero-based budgeting needs to be taken into consideration in areas of business where there is a huge number of indirect costs that do not make sense so that the quick targets can be recognized. This will help reinforce the choices being made by the organization and will also lead to saving up on costs. Zero-based budgeting can also be put into action in large and stable business areas that are chasing profits or stability.
#3 Have A Team Instead Of Doing It Alone:
You will not be able to achieve your goals effectively if you pursue this budgeting method alone. It is quite difficult and time-consuming, so you need to have a proper team with members from IT, finance, and other departments as well. Although hiring a team will prove to be more expensive, it will definitely be beneficial in the long run as the budget will be well managed and known by every department.
#4 Select A Suitable Planning Platform:
For zero-based budgeting to be a success, you need to have complete insight into the performance. For that, you will need the best possible planning platform. Older systems contain highly aggregated data mostly in the form of spreadsheets. Editing these spreadsheets can be a hassle as it can be very confusing and demanding. A more suitable and better option would be to use an analysis platform that will hold all your details and data in a format that is easy to understand and access.
#5 Keep Sustainability In Mind:
Once you start with zero-based budgeting and end up being successful with it, don’t just stop there. Continue refreshing and improving your skills as you go. If you return to the way the organization was before, then it won’t be beneficial at all. You need to continue with zero-based budgeting in the long run.
You would have to be very careful with the techniques and steps you implement for zero-based budgeting. Make sure everything is done smartly with details and reasoning clearly stated for every action you take. Even though zero-based budgeting is time-consuming, it can be very useful for your organization in the long run as it helps cut down on costs by a significant amount. Less cost means more profit. After all, profit is the main goal for most organizations and even if it isn’t, cutting down costs will still prove to be beneficial. Now that you have all that you need to know about zero-based budgeting, you can easily implement the related tips and strategies on your organization and lead it to success.