What is Zero Based Budgeting?
A budget shows the planned financial outcome of a business based on its current intentions and objectives and can be prepared using either the traditional approach or the zero based budgeting approach.
The traditional approach involves using historical financial information (usually the previous years financial statements), and adjusting these for growth, inflation, and other known factors, to arrive at the next years budget. For example, if a particular expense last year was 50,000, the business might anticipate a 2% increase for the year and budget the expense for next year at 51,000.
In contrast, zero based budgeting does not assume that the business will remain the same from one accounting period to another and allocates a zero budget to each expense until a case has been put forward to justify the allocation of a budget to it.
In order to undertake zero based budgeting, each year the business must consider what it is currently doing and where it plans to go. In the above example, zero based budgeting would consider whether the expense of 50,000 was needed at all, and whether and how the business could be changed to reduce the need for the expense.
Advantages of Zero Based Budgeting Approach
Some of the advantages of zero based budgeting are as follows:
- Since every budget is set to zero, zero based budgeting requires all items to be considered.
- The final budget is based on the the future plans and objectives of the business
- It avoids simple inflationary increases to expenses without due consideration.
- It eliminates waste and inefficiency resulting in cost savings.
Disadvantages of Zero Based Budgeting Approach
Zero based budgeting also has its disadvantages including the following:
- It is time consuming as each year the budget is started from scratch.
- Zero based budgeting may require additional staff training.
- Conflicts can arise each year as each department attempts to justify its budgetary allocation.
For further information see the Wikipedia definition.
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