Zero Based 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 re-valuated each time a budget is set."
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.