Explain the concept of Zero-based Budgeting. What are its pre conditions ?
Explain the concept of Zero-based Budgeting. What are its pre conditions ?
Meaning
This budget is the preparation of budget starting from Zero or from a clean state. As a new technique it was proposed by Peter Pyher of Texas Instruments Inc., U.S.A. This technique was introduced in the budgeting in the state of Gorgia by Mr. Jimmy Carter who was then the Governor of that state. When Mr. Carter later on became President of the U.S.A., ZBB. was tried in federal budgeting as a means of controlling state expenditure.
The use of zero-base budgeting (ZBB) as a managerial tool has become increasingly popular since the early 1970s. It is steadily gaining acceptance in the business world because it is proving its utility as a tool integrating the managerial function of planning and control.
ZBB is a method of budgeting in which all expenses must be justified for each new period. ZBB starts from a ‘zero base’ and every function within organisation is analysed for its needs and cos Budgets are then built around what is needed for the upcoming period regardless of whether the budget is higher or lower than the previous one. ZBB allows top-level strategic goals to be implemented into budgeting process by tying them to specific functional areas of the organisation, where costs can be first grouped, then measured against previous results and current expectations.
Conventional Budgets are prepared mainly on past performance and actual costs. Thus a conventional budget represents a quantification of the firm’s objectives and the efficiency of budgeting as a planning and control device depends upon the activity in which it is being used. Budgets are best used as a managerial control in activities which are directly related to the final output of the organisation because the inputs used by these activities can be compared with the output of these activities.
Thus, a more accurate budget can be framed once the relationship between inputs and outputs is established. But there are some activities which are not directly related to the firm’s output such as the legal staff and the personnel office.
A more accurate budget cannot be developed for such activities because the tasks assigned and resources allocated to such activities are not directly related to the firm’s output and it is difficult to develop and use standard cost for such activities. Zero-base budgeting is most appropriate in controlling these staff and support areas, (i.e. non-manufacturing overhead). A conventional budget is developed mainly on the concept of incrementalism. Under this approach cost levels of the previous year are often taken as a base to start within and budget units focus their attention on ascertaining what changes from the previous year are required. Thus, a budget is developed on the basis of incremental changes from the previous year’s figures taken as base.
An incremental approach to budgeting carries forward previous year’s inefficiencies and extravagances because previous year’s figures are taken as a base for the development of a budget. Thus incremental approach does not promote operational efficiency because it does not require managers to review their past activities.
On the other hand, zero-base budgeting is not based on the incremental approach and previous year’s figures are not adopted as a base. Rather, zero is taken as a base as the name goes. Taking zero as a base, a budget is developed on the basis of likely activities for the future period.
In ZBB, by delinking the budget from the past, the past mistakes are not repeated. Funds required for any activity for the next budget period should be obtained by presenting a convincing case. Funds will not be available as a matter of course.
Steps in ZBB
The important steps in ZBB are:
(i) Identification of decision units in order to justify each item of expenditure in their proposed budget.
(ii) Preparation of Decision Packages. Each package is a separate and identificable activity. These packages are linked with corporate objectives.
(iii) Ranking of decision packages based on cost benefit analysis.
(iv) Allotment of funds based on the above resulting by following pyramid ranking system to ensure optimum results.
Decision packages are self contained modules or proposals seeking funds. Each decision package will clearly explain the activity, the need for the item, the amount involved, the benefit of implementing the proposal, the loss that may be incurred, if it is not done etc.
