What is Zero-based budget (ZBB)?
Zero-based budgeting (ZBB) is a budgeting method that entails creating a new budget from scratch each time, as opposed to starting with the previous period's budget and adjusting it as needed.
A zero-based budget assumes no activities and starts justifying everything with an initial value of zero i.e. it doesn’t consider the previous year’s budget.
In business, the planning of each functional area (department) of the organization’s budgeting is done from zero to implement the top-level strategic goals, where costs can be first grouped and then compared with previous results and current expectations.
Because of its detail-oriented nature, ZBB may be a multi-year process, with managers or group leaders reviewing a few functional areas at a time. ZBB can help reduce costs, by avoiding blanket increases or decreases to a prior period’s budget. It is, however, a time-consuming process that takes significantly longer than traditional methods.
Advantages of Zero-based budgeting
ZBB as an accounting practice has several advantages, including focused operations, lower costs, budget flexibility, and strategic execution. When managers consider how each dollar is spent, the highest revenue-generating operations become more visible. Meanwhile, lower costs may result because zero-based budgeting prevents resource misallocation that can occur over time when a budget grows incrementally.
Disadvantages of Zero-based budgeting
There are several drawbacks to ZBB. For starters, it is both timely and resource-intensive. Because a new budget is created for each period, the time investment may not be worth it. Using a modified budget template instead may be more beneficial. Second, it may reward short-term thinking in the company by allocating more resources to operations that generate the most revenue.