Zero Based Budgeting

Using Zero Based Budgeting to Improve Your Business Finance Management

Understanding Budgeting and How it Can Impact Your Business

Zero based budgeting is a technique that is practiced by justifying all expenses for each designated period of time. It begins with a base of zero and then performs an analysis of every function of the company so that an understanding of its requirements and expenses can be determined. From there, a budget is established on a foundation of the necessities for the next period of time, regardless of whether it is a larger or smaller budget than the one established for the last period.

The method of zero based budgeting means that you will need to place every dollar of expense or earning (or savings) into a designated category. Before anything happens with your money, it will have been recorded in a budget.

The 5 steps for successful zero based budgeting

This budgeting technique has five primary steps that must be followed in order to be used successfully. They are:

1.    Reviewing the organization’s strategy – this makes certain that the strategy of your organization and its value drivers are accurate and usable.

2.    Analyzing the needs and expenses at the zero base – here, the various functions of your business are identified and, where possible, they are consolidated.

3.    Reviewing the results – an operating budget should be developed that will align with the revised list of functions created in step 2, and the expenses associated with those functions.

4.    Executing the changes – once the necessary changes to the functions and their expenses are identified, they must be put into place.

5.    Monitoring performance – the actual performance of the operating budget should be continuously monitored and measured so that updated forecasts can be made and appropriate budgetary alterations can be put into place to ensure that the numbers remain accurate and useable.

The advantages of using zero based budgeting

By properly utilizing this budgeting technique, you will make certain that you know what is happening with every dollar earned, spent, or saved. This way, if you spend less than anticipated or if you earn a greater amount, then that money can easily be redirected into the area of your organization that requires it the most, instead of simply letting it be frittered away through spending that isn’t adequately focused. Other advantages include the following:

·         Resources are efficiently and appropriately allocated for the needs and costs of the functions of the organization

·         Managers are encouraged to seek out ways to improve operations for greater cost efficacy

·         Managers can take a more critical look at the services that are being offered and the ways in which they are being provided

·         Inflated forecasts are more quickly and easily identified

·         Departments and teams have boosted motivation by providing increased responsibility and initiative for decision making

·         It can be used for both product and service businesses where an output is more challenging to recognize

·         Operations that are wasteful or obsolete can more quickly and easily be identified and then eliminated

·         Communication and coordination among the various parts of the business are more frequent and effective

·         Outsourcing opportunities are identified

·         Cost centers are obligated to define their purpose and its connection to the goals of the organization.

The disadvantages of using zero based budgeting

As with just about everything in life and in business, while there are many advantages to using these budget techniques for your business, there are some drawbacks as well. Before getting started, make sure that you understand the bad as well as the good so that you can compensate for the shortfalls of this method. Some of the disadvantages include:

·         It can be challenging to define the various decision units and packages, as the process can both consume a great deal of time, and be exhaustive.

·         Zero based budgeting will require that the managers be well trained, as it must be very thoroughly understood in order to be implemented properly. If it is not practiced accurately throughout the company, then its entire value could be lost.

·         Depending on the size of the company, the number of functions it performs, the number of departments or locations it has, and other factors, the process of budgeting could create a tremendous volume of forms that makes all of the documenting unusable, requiring the information to be compressed to an appropriate and practical size – possibly losing critical details.

·         As the success of budgeting is dependent on accuracy, the information presented by every single manager must be reliable, uniform, and honest. Even one manager that is inclined to exaggerate can throw off the results of the budget. 

Using this budgeting concept can do a tremendous amount for your company and its ability to stick to its strategy, when it has been performed properly. For the most favorable results, make sure that you and your staff have been properly trained, and that a universal understanding of the process and requirements is established across your organization.