Zero-Based Budgeting

Zero-Based Budgeting (ZBB) is a budgeting approach that starts from a baseline of zero for all budget lines, requiring organizations to justify each expense anew for every budgeting cycle. This method aims to combat institutional inertia, where organizations may continue past spending habits without assessing current needs or inefficiencies. By reevaluating all activities and determining their necessity and cost, ZBB aligns an organization's resources with its mission and goals.

Though it can drive innovation by encouraging fresh perspectives and cost-effective solutions, ZBB is often not adopted as a standard method due to its time-consuming nature and the potential for resistance among departments. Different units may feel protective over their resources, leading to conflict during the reevaluation process. Furthermore, although ZBB can yield significant cost savings, organizations must carefully consider the allocation of these savings to avoid competition and discontent among departments.

Despite its advantages, ZBB's complexity and the need for thorough analysis can lead to challenges in execution, making it essential for organizational leaders to assess their environment and culture before implementation.

Published in: 2021

By: Zimmer, Scott, JD

Subject Terms

Zero-Based Budgeting

Abstract

Zero-based budgeting takes as its basis a value of zero for all budget lines. Then, as the budget is built up, the only funds that are incorporated into it are those that are necessary for the functions that the organization decides to perform. Zero-based budgeting is therefore a way for an organization to reevaluate, at a very basic level, all of its activities, to determine whether they are still necessary or can be eliminated.

Overview

The purpose behind zero-based budgeting is to overcome what might be termed institutional inertia. This is the tendency for organizations to keep doing what they have been doing for no other reason than that it is what has been done before. The problem with being controlled by inertia in an organization is that the environment of the organization and the factors influencing it are constantly changing, therefore demanding changes in what the organization does and how it accomplishes this work. If an organization bases its current year budget on the same budget as the year before, allow increases only due to inflation, then over time its operation will be out of synch with its environment and the needs imposed by that environment. Zero-based budgeting is an attempt to reconnect the organization’s operating procedures with its mission and goals. It does this by starting from scratch, taking as its basis a value of zero for all budget lines, looking at each of the goals the organization wants to accomplish, and determining what it would cost to meet those goals, whether the cost is derived from equipment, infrastructure, or personnel (Wolf, 2015).

Given the many advantages of zero-based budgeting one could easily wonder why it is not the default system used by organizations. The reason that it is more often aspired to than actually followed is that it is incredibly time-consuming. This is because developing a zero-based budget entails a reevaluation of the organization’s activities and the specific ways those activities are undertaken. While this might sound simple enough in theory, in practice it becomes extremely challenging to marshal all of the organization’s resources and constituencies to provide information and insight into these activities, while also carrying on the ordinary, day-to-day business of the organization. Another issue that tends to arise during the implementation of zero-based budgeting is the tendency of different units within an organization to resist some or all of the zero-based budgeting efforts.

Resistance can have a number of reasons, one of which is territoriality (Palmer, 2014). It is common for people to feel possessive about the resources that they are responsible for in the organization, as well as what it is done with those resources. For example, in a large retail organization, the department that handles packing and shipping of goods to consumers has its own system for getting its work done. This includes its own position descriptions, its own variety and types of supplies, and its own set of vendors that it is accustomed to doing business with. If this department were to begin zero-based budgeting it would need to reevaluate all of the choices that have been made in these different areas, considering the possibility of switching to different vendors, of using different supplies, and even changing the job descriptions of its employees, if a more efficient or effective distribution of labor appeared to be necessary. In many cases, the purpose and functioning of zero-based budgeting is not adequately explained to all members of the organization, so when they are asked to reevaluate everything they do on a daily basis, some people may take this as a challenge to their own competence. When this occurs, an additional obstacle is added to those that are already present in the zero-based budgeting effort, namely resistance. Not only will the organization have to deal with this tendency, it will also still need to continue with its zero-based budgeting efforts in addition to conducting its day-to-day operations (Réka, Ştefan & Daniel, 2014).

Applications

One of the main advantages to zero-based budgeting is that it provides an organization with an opportunity to innovate. Often innovation is thought of in terms of inventing a new device or process that has never been seen before in the marketplace. There are also innovations that are less transformative yet have a major impact on an organization’s finances (Chinniah, 2013). An example of these types of innovations could include a new inventory system that no longer requires scanning barcodes but relies instead upon wireless reading of RFID tags that are easier to access and use. The new system could offer substantial savings in the future, in exchange for the up-front cost of converting from barcodes to RFID.

In a traditional budgeting system there would always be a disincentive to innovate in this way because of the initial startup cost. This initial startup cost would appear to be a sizeable increase over the previous year’s activities and would be difficult to explain to budget managers. In a zero-based budgeting system, however, the analysis begins from ground zero. That is, it starts without any assumptions about how things should be done and how things have been done. It simply looks at the most cost-effective way of doing things from the present point in time forward. Under this type of budgeting system, the decision to go with RFID inventory management would be an obvious choice because of its simplicity and efficiency. The cost to convert from the old system would not have to be justified, because it would not be compared to the previous system under the assumption that the previous system was good enough and the new system might not produce a large enough savings to justify its initial expense (Gondim, 2017).

Zero-based budgeting is often used in the case of mergers and acquisitions among businesses. Mergers and acquisitions can become quite complicated from a financial perspective, because each organization has its own internal structure of departments, each with their own budgets, and it often happens that these are duplicated in the other organization. For example, if two airlines decided to merge their businesses, more than likely each airline would have its own finance office. The new, merged company would not need two finance offices; therefore the two offices and processes would need to be consolidated. This is complicated in a number of ways, including human resources, office space, and even details as specific as what type of software is used for tracking financials. Trying to merge these two departments could become very time-consuming and complex, so it is often found that a zero-based budgeting approach works much better, because the two organizations will have a fresh start, consider what their needs are going to be for the future, and then allocate the resources appropriate to meet those needs. The alternative would be to try to fuse together two potentially very different systems and hope that they would somehow get along with one another and support the organization’s activities (Glass, Stefanova & Prinzivalli, 2014).

A function that is often touted as an advantage of zero-based budgeting is the concept of forensic visibility. Forensic visibility is a fancy way of saying that one has a clear understanding of who in the organization is spending, in what amounts, and for what reason. While these may seem like simple questions, in large organizations it can be challenging, even for members of the finance office, to discover this information. Forensic visibility, while valuable, is not so much a part of zero-based budgeting as it is a by-product of zero-based budgeting. This is because zero-based budgeting requires a minute analysis and understanding of the organization’s activities, including how it spends its money. This type of analysis is essentially equivalent to forensic visibility.

Time and again, exercises in forensic visibility result in reactions of surprise and exasperation, as members of the end of the analysis team realize that the organization is spending significant amounts of money in ways that are difficult to justify. One example of this that frequently occurs is an organization’s use of outside printing, copying, and shipping services. In many cases, the organization has its own internal departments for these functions, such as a print shop and mailroom. However, for a variety of reasons, some segments of the organization either do not know about these internal services or are not satisfied with them, and therefore use external organizations. These external organizations are typically profit-motivated, so the services they provide are more expensive than would be the cost of using the internal alternatives. Zero-based budgeting, by using forensic visibility as one of its tools, can identify these types of situations, as well as the savings that could be realized by discontinuing the use of the external organizations and transitioning to reliance on those internal to the company (Bosch-Badia, Montllor-Serrats & Tarrazon-Rodon, 2015).

Issues

A major concern that arises with zero-based budgeting is how savings are allocated. Usually zero-based budgeting efforts result in noticeable savings in some, if not all, budget lines. As discussed above, this comes at the price of intense scrutiny, and this can be very time-consuming and requires the cooperation of many parties within the organization. Invariably some departments express concern that they are being asked to expend a large amount of effort cooperating with zero-based budgeting activities, only to have the savings that are realized be allocated elsewhere in the organization (Robinson, 2014). This can contribute to a sense of competition and even antagonism developing between departments, as a department that identifies savings looks unfavorably upon another department that it views as irresponsible or inefficient.

Organizations can approach this issue in several different ways. Some organizations attempt to keep savings identified through zero-based budgeting within the department in which they originated. This provides a clear incentive for departments to identify such savings, because they will know that they will still have access to the funds, but that they will be able to use them for a more productive purpose. The disadvantage of this strategy is that it may not be the most efficient use of saved funds to keep them in the same department; an improvement on past procedures may create a lean department that does not require the funds it has saved through efficiency, whereas those funds could be invested in training or technology upgrades in another department. Another way that organizations sometimes respond to the potential for conflict over the allocation of savings is by making an effort throughout the company to encourage a cooperative mindset in the hopes that all employees will understand that they are working toward the same goal, which is not the success of their particular part of the organization, but the success of the organization as a whole (Abdel-Monem, Herian, Hoppe, PytlikZillig & Tomkins, 2016).

Globally, the current trend is toward a lower rate of usage of zero-based budgeting in organizations engaged in cost-reduction efforts. This is part of the paradoxical nature of zero-based budgeting. Zero-based budgeting tends to be successful in reducing costs at a slightly greater rate than other methods of cost reduction. However, organizations that pursue zero-based budgeting also experience greater resistance due to its complexity. This means that it is often unclear whether an organization should pursue zero-based budgeting. On paper the case in favor of a zero-based budget may seem clear, but organizational leaders, who have an intimate knowledge of their organization’s culture, must take into account the degree of resistance they are likely to experience if they choose a zero-based budgeting approach.

For example, a company worth $10 million might consider zero-based budgeting in the hope of attaining a projected savings of $100,000 annually. At the same time, the company’s projected costs of undertaking zero-based budgeting might exceed the amount of savings anticipated, or might reduce the savings by so much as to make the undertaking hardly worthwhile. So, if it costs the company $90,000 in its effort to save $100,000, this would mean overall savings of only $10,000, which would hardly be justifiable considering the amount of frustration that can be generated during a year-long zero-based budgeting effort.

When zero-based budgeting first gained popularity as a concept, this type of analysis was not yet fully understood. The tendency was for organizations to underestimate the costs of zero-based budgeting and resistance among their staff. This resulted in a number of zero-based budgeting efforts that produced results far below what was expected. Over time, the reputation of zero-based budgeting declined due to the sense that it was not as fruitful as its proponents made it out to be. This is not to say that zero-based budgeting is a financial approach without merit, but it is one that is most successful when an organization’s leadership is fully engaged and its personnel have a positive attitude toward change and the idea of working together to improve everyone’s situation (Lauth, 2014).

Terms & Concepts

Acquisition: The purchase of another company by another, which takes control of the acquired company and often reallocates its resources to align with the needs of the new parent company.

Budget Surplus: Represents an amount of money in a budget line that is not spent during the budget period. The surplus can be seen as savings.

Cash Budget: An organization’s cash budget tracks the organization’s cash reserves while excluding assets that are in other forms, such as real estate or other types of property that cannot easily be liquidated. The cash budget is often referred to when assessing the organization’s financial health.

Cost Drivers: Factors that can cause a particular activity to become more expensive than anticipated. For example, one of the cost drivers for transportation expenses would be the price of fuel.

Forensic Visibility: The ability to identify within a budget what amounts of money are being spent, by whom, and for what purpose. Forensic visibility is a key feature of zero-based budgeting.

Merger: A merger occurs when two companies, through mutual agreement, decide to join together and form a single entity. In comparison with an acquisition, a merger requires a greater deal of negotiation and compromise.

Static Budget: A static budget remains the same throughout the budgeting period. In contrast, some budgets have their amounts tied to fluctuating factors such as sales or student enrollment, so that if sales go up, the budget for a particular line may go up also.

Bibliography

Abdel-Monem, T., Herian, M. N., Hoppe, R., PytlikZillig, L. M., & Tomkins, A. J. (2016). Policymakers’ perceptions of the benefits of citizen-budgeting activities. Public Performance & Management Review, 39(4), 835–863. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=116238221&site=ehost-live

Bosch-Badia, M.-T., Montllor-Serrats, J., & Tarrazon-Rodon, M.-A. (2015). Corporate social responsibility: A real options approach to the challenge of financial sustainability. PLoS ONE, 10(5), 1–37.

Chinniah, A. (2013). An assessment of zero-based budgeting to protect the leakage of finance in government and an organizational development. CLEAR International Journal of Research in Commerce & Management, 3(5), 1–10. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=113658376&site=ehost-live

Glass, V., Stefanova, S., & Prinzivalli, J. (2014). Zero-based budgeting: Does it make sense for universal service reform? Government Information Quarterly, 31(1), 84–89. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=94509854&site=ehost-live

Gondim, F. G. (2017). Generating great results through ZBB. Journal of Private Equity, 20(2), 12–14. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=121696639&site=ehost-live

Lauth, T. P. (2014). Zero-base budgeting redux in Georgia: Efficiency or ideology? Public Budgeting & Finance, 34(1), 1–17. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=94857499&site=ehost-live

Palmer, J. C. (2014). Budgeting approaches in community colleges. New Directions for Community Colleges, 2014(168), 29–40.

Réka, C. I., Ştefan, P., & Daniel, C. V. (2014). Traditional budgeting versus beyond budgeting: A literature review. Annals of the University of Oradea, Economic Science Series, 23(1), 573–581. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=97635608&site=ehost-live

Robinson, M. (2014). Spending reviews. OECD Journal on Budgeting, 2013(2), 1–42.

Wolf, R. (2015). Broken Budgets? Strategic Finance, 97(6), 22–29. Retrieved January 1, 2019 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=103029698&site=ehost-live

Zero-Based Budgeting

On this Page

Subject Terms

Zero-Based Budgeting

Abstract

Overview

Applications

Issues

Terms & Concepts

Bibliography

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