Zero-based Budgeting

➢ Zero-based budgeting(ZBB) is the method of budgeting in which managers

are required to start at zero budget levels every year and to justify all costs as
if the programs involved were being initiated for the first time. No costs are
viewed as being ongoing in nature; the manager must start at the ground level
each year and present justification for all costs in the proposed budget
regardless of the type of costs involved.
➢ Zero-based budgeting (also known as priority-based budgeting) emerged in
the late 1960s as an attempt to overcome the limitations of incremental
budgets. This approach requires that all activities are justified and prioritized
before decisions are taken relating to the amounts of resources allocated to
each activity. Besides adopting a ‘zero-based’ approach zero-base budgeting
(ZBB) also focuses on program or activities instead of functional departments
based on line items, which is a feature of traditional budgeting. I[Durry,
2000]
➢Zero-based budgeting though is not really new concept; it is the review of the
departmental costs. Managers are advocating, for long, an in-depth review of
departmental costs. This review should be done annually, zero-based budgeting
lays down whereas critics of zero-based budgeting say it should be done every
five years or so. The only difference is the frequency of the review of
departmental cost. [Garrison, 2000]
➢Under zero base budgeting, every budget is constructed on the premise that
every activity in the budget must be justified. It starts with the basic premise
that the budget for the next year is zero and that every expenditure, old and
new, must be justified on the basis of its costs and benefits. The discipline of
zero-base budgeting takes a different approach – in fact a reverse approach to
this problem of justifying everything. What it says is ‘begin with where you are
and establish a business as usual and budget for the next year in the same way
and with the same things you would do if you were not concerned about
constraints and total justification.
➢Zero-based budgeting differs from traditional budgeting in which budgets are
generally initiated on an incremental basis; the managers start with the last
year’s budget and simply add to it according to anticipated needs. The
manager doesn’t have to start at the ground level each year and justify the
ongoing costs for existing programs.
➢ZBB is suitable for both corporate and non-corporate entities like Government
department, local bodies, not for profit organizations, where these entities need
to justify the benefits of expenditures on social programmes like mid-day
meal, installation of street lights, provision of drinking water etc. In case of
corporate entities, ZBB is best suited for discretionary cost like research and
development cost, training programmes, advertisement etc.
Features of Zero Based Budgeting
i. The budget allotment to any decision unit should be first justified by
the manager of that decision unit. S/he should justify his/her request
without making any reference to previous level of spending in his/her
decision unit.
ii. Activities are identified as decision packages and then latter are ranked
in order of priority.
iii. Decision packages are evaluated by systematic analysis linking them
with clearly laid down corporate objectives.
iv. A frank relationship exists between superiors and subordinates.
v. Available resources are directed towards alternatives in order of priority
to ensure optimum results.
Objectives of Zero Based Budgeting
i. To justify the resources requirement for existing activities as well as new
activities.
ii. To establish for all managerial level in any agency, objectives against
which accomplishment can be identified and measured.
iii. To assess alternative methods of accomplishing objectives.
iv. To analyze the probable effects of different budget amount or
performance level on the achievement of objectives.
v. To provide a credible rationale for reallocation of resource, especially
from old activities to new activities.
Advantages of Zero-based budgeting:
i. Allocation of Resources
ii. Helps in evaluation
iii. Departmental budget is enabled
iv. No need for recycling of budget inputs
v. Priority based
vi. Communication
vii. Helps to judge commitments
i. Allocation of resources: ZBB provides the organization with a systematic way to evaluate
operations and programmes of activity, and allows management to allocate resources according to
the priority of programmes.
ii. Helps in evaluation: It ensures thorough examination of every function. Managers are required to
evaluate the need for every programme, and to consider different levels of effort and alternative
way of performing operations.
iii. Department budget is enabled: It enables departmental budgets to be approved on the basis of
cost-benefit comparison rather than be open to any arbitrary cuts or increase in budget estimates.
iv. No need for recycling of budget inputs: If decision packages are ranked in order of priority,
subsequent budget cycles do not have to be based on a complete recycling of budget inputs.
v. Priority based: If available resources vary from budgeted estimates during the budget year,
decision package can be reduced or expanded on the basis of priority ranking of packages.
vi. Communication: Long-range goals and plans can be linked with the annual budgets through the
zero-based budget. Not only does it facilitate quantification of costs and benefits of contemplated
decisions, but also enables managers to communicate problems and opportunities to the higher
management.
vii. Helps to judge commitments: The performance of line managers can be judged against their
commitments in terms of the approved decision packages and their budgets.
Limitations of Zero Based Budgeting
The limitations of ZBB, which arise due to certain operational problems, are as follows:
i. Implementation problem: Successful implementation of ZBB may require
wholehearted support from the top management, which many not readily be available
owing to fear and problems in the mind of top management. The concerned mangers
should continue in the same decision units. If they are transferred frequently to other
departments, it may lead to waste of time and resources in training and developing
new managers.
ii. Formulation problems: Considerable problem may arise while formulating decision
packages. For instance, problems may arise in the fixation of minimum level of
effort. Manager may not like to fix the minimum level below the current levels.
Similarly, problems may raise in formulating meaningful performance evaluation
measures.
iii. Ranking problems: Problems may arise in ranking of decision packages. General
managers may like to continue their favorable projects for the reasons based known
to them. Ranking may also become difficult when there are a large number of
decision packages, particularly in a multi-product manufacturing firm.
Stages in Zero-based budgeting (ZBB)
i. Identification and description of decision packages: A decision package is a
comprehensive description of a facet of the organization’s activities or functions
which can be individually evaluated. The decision package is specified by the
managers concerned and must show details of the anticipated cost and results
expected expressed in terms of task accomplished and benefits achieved. Two types
of decision packages:
▪ Mutually-exclusive decision packages: These are alternative forms of activities, tasks
and expenditure to carry out the same job. The best option among the mutually
exclusive packages is selected by comparing cost and benefits, and other packages
are then discarded. Naturally, mutually exclusive packages would only be prepared
when there are quite clearly different approaches for dealing with the same function.
As an example, an organization with a distribution problem might consider two
alternative decision packages: Package 1 might be an in-house fleet of lorries,
whereas package 2 could involve contracts with independent haulers.
▪ Incremental decision packages: These packages reflect different levels of efforts in
dealing with a particular activities. There will be, what is known as the base package,
which represents the minimum feasible level of activity and other packages which
describe higher activity level at given cost and resulting benefits. As an example, a base
package for a personnel department might provide for staff engagement and termination
procedures and payroll administration. Incremental packages might include: education
and training, welfare and social activities, pension administration, liaison and
negotiations etc. Each package would have its costs and benefits clearly tabulated.
ii. Evaluation and Ranking (Prioritization) of decision packages:
When the decision packages have been prepared, management will then rank all the
packages on the basis of their benefits to the organization. This is a process of
allocating scarce resources between different activities, some of which already exist and
others that are new.

Minimum requirements which are essential to get the job done and activities
necessary to meet legal or safety obligations will naturally receive high priority. It will
be found that the ranking process focuses management’s attention on discretionary or
optional activities.
Because of the large number of packages prepared throughout the organization the
ranking process can become onerous and time consuming for senior management. One
way of reducing this problem is for lower level managers to rank the packages for their
own budget center and for these rankings to be consolidated, with others, at the next
level up in the hierarchy. Alternatively, these could be ranked within the department and
need not be referred higher.
iii. Allocation of resources:
When the overall budgeted expenditure level is decided upon the packages
would be accepted in the ranked priority sequence of up to the agreed
expenditure level.
Where the ranking of lower cost packages has been delegated to
departments, the proportion of the expenditure budget remaining after
more expensive packages have been ranked would be allocated to
individual department. The departments would then rank their own small
packages up to their allocated expenditure level.