Friday, October 09, 2015

Zero Base Budgeting: Meaning, Benefits, Limitations and Steps

Zero Base Budgeting
ZBB is defined as ‘a method of budgeting which requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time. Without approval, the budget allowance is zero’.
Zero – base budgeting is so called because it requires each budget to be prepared and justified from zero, instead of simple using last year’s budget as a base. In Zero Based budgeting no reference is made to previous level expenditure. Zero based budgeting is completely indifferent to whether total budget is increasing or decreasing. 
‘Zero base budgeting’ was originally developed by Peter A. Pyher at Texas Instruments. Peter A. Pyher has defined ZBB as “an operating, 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 we should spend any money at all”.
CIMA has defined it “as a method of budgeting whereby all activities are revaluated each time a budget is set."

Benefits and Limitations of Zero Base Budgeting
The major benefits(Need) of the use of zero base budgeting can be the following:

a)      Zero base budgeting examines all existing and new programmes and activities. It also makes the managers analyse their functions, establish priorities and rank them. This exercise helps in identifying inefficient or obsolete functions within the area of responsibility. In this way resources are allocated from low priority programmes to high priority programmes.
b)      This system facilitates identification of duplication of efforts among organisational units. Such inefficient activities are eliminated and some other activities are merged. 
c)       All expenditures, under this system are critically reviewed and justified and all operations activities are evaluated in greater detail in terms of their cost- effectiveness and cost-benefits. This requires managers to find alternative ways of performing their activities which may result in more efficient procedures. 
d)      ZBB promotes the tendency to initiate studies and improvements during the period of operation as the persons at the helm of affairs know that the process would be exercised next year and their knowledge and training would enhance efficiency and cost-effectiveness. 
e)      ZBB provides for quick budget adjustments during the year. If revenue falls short in this process, it offers the capability to quickly and rationally modify goals and expectations to correspond to a realistic and affordable plan of operations. 
f)       ZBB ensures greater participation of personnel in formulation and ranking processes. This helps in promoting level of job satisfaction and thus resulting in better control and operational efficiency in the organisation. 
g)      Zero base budgeting is a flexible tool that can be applied on a selective basis. It does not have to be applied throughout the entire organisation or even in all the service departments. Keeping in view the limitations of time, money and persons available to install, operate and monitor it the management thus can select priority areas to which zero base budgeting may be applied. 

Limitations of ZBB can be summed up as:
a)      It challenges the past practices, performance, attitudes, of people. 
b)      It requires more time and effort. 
c)       Detailed costs and necessary information for decision packages often are not made available. 
d)      It increases paper work to unmanageable proportions. 
e)      Ranking a large number of decision packages becomes an unwieldy process. 
f)       Identifying various levels of funding, particularly the minimum level is a difficult task.

Steps in Zero-Base Budgeting
a)      Determination of Objectives: The first step in ZBB is the clear definition of the objectives of budgeting. The objective may be to reduce expenditure on staff, to discontinue an activity or project in preference to another etc.
b)      Determination of the Extent of Application: Whether ZBB should be introduced in all operational areas or only in some selected areas is to be decided.
c)       Identification of Decision Units: Decision unit refers to a department, a project or a product line to which ZBB is to be applied. Identification of such units is done in consultation with managers.
d)      Cost-Benefit Analysis: Cost benefit analysis is undertaken for each activity of the decision unit. It provides answers to the following questions.
1.       Is it necessary to perform the activity at all? If the answer is in the negative, there is no need for proceeding further.
2.       How much is the actual cost and what is the actual benefit of the activity?
3.       What is the estimated cost and estimated benefit of the activity?
4.       If the unit is dropped, can the unit be replaced by outside agency?

e)      Preparation of budgets: The activities and projects for which benefit is more than the cost are ranked. Priority is accorded to the most profitable projects/activities, in the allocation of funds.