What is Zero Based Budgeting?
Zero based budgeting (ZBB) is a budgeting method that involves starting with $0 and adding only enoughin the budget to cover expected costs.
Zero-Based Budgeting Example
There are many ways to create company budgets. Let's take Company XYZ as an example. Last year, the firm's marketing department spent $1 million. What's the right way to set a budget for next year?
You might simply give the department $1 million again, but this might not reflect the changes in the marketing programs next year, the need to hire more marketing staff, or a host of other.
Another way might be to give all departments a 10% increase or decrease based on guidance from the company's board of directors. This would give the department $1.1 million or $900,000, depending on which direction the board goes.
A third way would be zero-based budgeting, whereby the department starts with no budgetedand must justify every person and expense that should be included in the budget for the coming year. This might result in a budget of, say, $1,024,314, which is higher than last year but reflective of the actual needs next year.
Why Zero-Based Budgeting Matters
Employees and managers often view budgeting as a game to beat rather than a cooperative planning exercise that incorporates goals and expectations. Many of us have heard of "slush" and "use it or lose it" philosophies in which departments try to hoard for undetermined uses just to avoid being penalized later.
Zero-based budgeting theoretically conquers this behavior by requiring department heads to understand everyoutflow and the costs of their operations. It also allows executives to get a genuine measure of what things cost in the coming and compare that to their performance expectations accordingly.
Some critics argue that justifying costs unduly penalizes functions that don't generate. It is also more analytical and time-consuming than budgeting methods that simply make blanket changes to last year's budget, thus requiring managers to be more educated about the financial aspects of their department operations.