Zero-Based BudgetingWhat is Zero-Based Budgeting and How is it used in Business + Pros & Cons

Written By:
Adiste Mae

Reviewed By:
FundsNet Staff

What is Zero-Based Budgeting (ZBB)?

When talking about Zero-Based Budgeting or ZBB, people automatically assume that the budget starts from zero or the difference after subtracting expenses from the income should be zero.

Although this is correct, perhaps the best definition of a ZBB is that for every income, every aspect of the expense is planned down to its tiniest detail, even when there is zero left in the budget.

In every organization, budgeting is key and there are different types of budgeting that organizations use.

With ZBB, each department of an organization identifies their needs and costs which are then translated to what their needed budget is for the next business cycle irregardless of whether or not the budget is higher or lesser than the previous budget.

In essence, their budget starts from a zero base.

How Zero-Based Budgeting (ZBB) Works

When companies prepare a Zero-Based Budget, the company requires that the strategic goals of the company are communicated through their budgets irregardless of previous years’ budget.

It requires a detail-oriented approach on budgeting which means that all of the amount assigned to a specific expense account has to be justified.

This allows for companies to have a budget that is relevant and cost-effective.

When an organization is able to implement a zero-based budget effectively, they will be able to reduce cost and increase spending efficiency.

Even with the advantages of this budgeting type, it can be a time consuming process and will require a regular review by managers of some functional areas of the organization.

Implementing ZBB may be time consuming but the process involves four steps that companies follow: the organization must identify the goals of the business, come up and analyze ways to achieve the business goals, determine the areas where functional areas can save money and other ways of funding and finally, prioritize the funds of the company.

Once these are all done, the company can begin to execute the budget.

ZBB is typically a practice of companies but can also be used by families.

With this type of budgeting, families can become more intentional in their spending by carefully allocating their income towards their spending priorities which are usually towards the household needs, investments or savings.

Zero-Based Budgeting vs. Traditional Budgeting

A lot of companies are more familiar with a traditional budgeting method.

In Traditional Budgeting, companies look at the previous year’s budget and add a certain percentage on the budget in order to account for inflation and salary increases.

Although this type of budget has worked for several years, there could be savings lost and missed opportunities there.

With Zero-Based Budgeting, companies start their budgets at zero.

The budgets of previous years will not become the basis for the new budget and what they will do is align the company’s strategies to the budget.

This allows for the company to focus on efficiency, cost reduction and savings.

In a traditional budget, companies only need to justify the increase from the previous year’s budget while in a zero-based budget, old and new amounts added to the budget need to be justified.

Example of Zero-Based Budgeting

A furniture manufacturing company has decided to implement ZBB for the next business cycle.

In the previous years, they have always used traditional budgeting and simply added a percentage of the previous years’ budget to come up with a new budget.

When the management reviewed their strategies for the coming year and after analyzing their purchasing process and reviewing their vendors, they found out that instead of buying raw timber from a local supplier and spending $30,000 a year, they can import timber from another country and spend $25,000 instead.

With ZBB, each expense has to be reviewed and justified unlike Traditional Budgeting that only takes last year’s budget and then adds an increase to the same expense account.

This allows for management to closely look at the effectiveness of how the company’s budget is spent and whether or not the money is worth the spend at all.

Special Considerations

Families can also use Zero-Based Budgeting. ZBB in personal budgets promotes accountability and intentional spending.

Families have goals too and it could be different for each year.

Last year’s budget may not be aligned with the goals of the family for the incoming year so they will have to plan their expenses from zero.

That means that for every dollar that a family earns, each dollar spent and saved has to be justified.

What Are the Advantages of Zero-Based Budgeting?

With the implementation of ZBB, companies are able to put greater focus on the strategic goals of the company and how the budget could help the company achieve their goals.

By justifying how each dollar will be spent, there is a greater chance that a company will be able to reduce costs, improve efficiency, and avoid the misallocation of the company’s funds.

In addition to that, ZBB allows for the management to collaborate and work closely together to understand clearly how each of the functional areas of the company function.

What Are the Disadvantages of Zero-Based Budgeting?

Implementing a zero-based budget can be very time-consuming and will be very resource intensive.

Preparing this budget yearly can end up with the company costing more because of the cost of time and resources required.

Coming up with a budget that starts each time at zero may be too complex for those who are involved with the budgeting process and while the company is able to focus on areas that generate more revenue, some areas might end up being overlooked.

To learn more about other types of budgets, read our article here: Types of Budgets.