Zero-Based Budgeting: What It Is and How to Use It (2024)

What Is Zero-Based Budgeting (ZBB)?

Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. The process of zero-based budgeting starts from a "zero base," and every function within an organization is analyzed for its needs and costs. The budgets are then built around what is needed for the upcoming period, regardless of whether each budget is higher or lower than the previous one.

Key Takeaways

  • Zero-based budgeting is a technique used by companies, but this type of budgeting can be used by individuals and families.
  • Budgets are created around the monetary needs for each upcoming period, like a month or a year.
  • Traditional budgeting and zero-based budgeting are two methods used to track expenditures.
  • Zero-based budgeting helps managers lower costs for a company.

How Zero-Based Budgeting (ZBB) Works

In business, ZBB allows top-level strategic goals to be implemented into the budgeting process by tying them to specific functional areas of the organization, where costs can be first grouped and then measured against previous results and current expectations.

Because of its detail-oriented nature, zero-based budgeting may be a rolling process done over several years, with a few functional areas reviewed at a time by managers or group leaders. Zero-based budgeting can help lower costs by avoiding blanket increases or decreases to a prior period's budget. It is, however, a time-consuming process that takes much longer than traditional, cost-based budgeting.

The practice also favors areas that achieve direct revenues or production, as their contributions are more easily justifiablethan in departments such as client service and research and development.

Zero-based budgeting, primarily used in business, can be used by individuals and families, too.

Zero-Based Budgeting vs. Traditional Budgeting

Traditional budgeting calls for incremental increases over previous budgets, such as a 2% increase in spending, as opposed to a justification of both old and new expenses, as called for with zero-based budgeting.

Traditional budgeting also only analyzes only new expenditures, while ZBB starts from zero and calls for a justification of old, recurring expenses in addition to new expenditures. Zero-based budgeting aims to put the onus on managers to justify expenses and aims to drive value for an organization by optimizing costs and not just revenue.

Example of Zero-Based Budgeting

Suppose a construction equipment company implements a zero-based budgeting process calling for closer scrutiny of manufacturing department expenses. The company notices that the cost of certain parts used in its final products and outsourced to another manufacturer increases by 5% every year. The company can make those parts in-house using its workers. After weighing the positives and negatives of in-house manufacturing, the company finds it can make the parts more cheaply than the outside supplier.

Instead of blindly increasing the budget by a certain percentage and masking the cost increase, the company can identifya situation in which it can decide to make the part itself or buy the part from the external supplier for its end products.

Traditional budgeting may not allow cost drivers within departments to be identified. Zero-based budgeting is a more granular process that aims to identify and justify expenditures. However, zero-based budgeting is also more involved, so the costs of the process itself must be weighed against the savings it may identify.

What Is Zero-Based Budgeting?

Zero-based budgeting originated in the late 1960s by former Texas Instruments account manager Peter Pyhrr. Unlike traditional budgeting, zero-based budgeting starts at zero, justifying each individual expense for a reporting period. Zero-based budgeting starts from scratch, analyzing each granular need of the company, instead of incremental budgeting increases found in traditional budgeting, Essentially, this allows for a strategic, top-down approach to analyze the performance of a given project.

What Are the Advantages of Zero-Based Budgeting?

As an accounting practice, zero-based budgeting offers a number of advantages including focused operations, lower costs, budget flexibility, and strategic execution. When managers think about how each dollar is spent, the highest revenue-generating operations come into greater focus. Meanwhile, lowered costs may result as zero-based budgeting may prevent the misallocation of resources that may happen over time when a budget grows incrementally.

What Are the Disadvantages of Zero-Based Budgeting?

Zero-based budgeting has a number of disadvantages. First, it is timely and resource-intensive. Because a new budget is developed each period, the time cost involved may not be worthwhile. Instead, using a modified budget template may prove more beneficial. Second, it may reward short-term perspectives in the company by allocating more resources to operations with the highest revenues. In turn, areas such as research and development, or those that have a long-term horizon, may get overlooked.

Zero-Based Budgeting: What It Is and How to Use It (2024)

FAQs

Zero-Based Budgeting: What It Is and How to Use It? ›

With a zero-based budgeting system, you want your income minus your expenses to equal zero at the end of each month. You will want to keep track of 100% of everything that you spend money on. The goal is to assign all of your income to specific categories until there's zero left over.

What is zero-based budgeting and how is it used? ›

A zero-based budget is a framework that assigns a job to every dollar of your take-home pay. In other words, you're aiming for what you bring in and what you send out to hit zero each month.

What is a zero-based budgeting approach to budgeting? ›

Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. The process of zero-based budgeting starts from a "zero base," and every function within an organization is analyzed for its needs and costs.

How do you use zero-based budget in a sentence? ›

The goal of a zero-based budget aims to make all of your income match your planned spending categories. At the end of the budgeting process, you have zero dollars left unassigned.

How does having a zero-based budget help you achieve your financial goals? ›

Needs come first, then savings and debt repayment, then wants. A zero-based budget can help you cut down on impulse purchases and unnecessary spending. You can take the money you would have spent and put it toward basic needs, allocate it to savings, or chip away at credit cards or other kinds of debt.

What is zero-based budgeting in real life example? ›

For example, let's say you're using zero based budgeting for your monthly expenses. You begin by listing all your sources of income, then allocate funds to different categories such as rent, groceries, utilities, and entertainment. This method encourages intentional spending and helps you maximize your money.

What best describes zero-based budgeting? ›

With zero-based budgeting, the budget is started from scratch or a “zero base” each year. Using this approach, every line of business within an organization is analyzed for its needs and costs while ignoring historic spending.

What is the step of zero-based budgeting? ›

Zero-based budgets start from zero, and you add in each expense as you approve it. With this technique, you reflect carefully on each expense and justify it thoroughly before allocating funds to it. Organizations can use zero-based budgeting to minimize waste, cut costs and increase profits.

Why zero-based budget is the best method of budgeting? ›

The zero-based budget is the best method of budgeting because: The zero-based budget ensures that every dollar you make is assigned a specific purpose. Which of the following is not a record-keeping feature you could expect from your bank?

What is a zero-based budgeting short term? ›

Zero-based budgeting differs from traditional budgeting in that the companies using it create a budget for each new period. The benefits can include lower costs by keeping old and new expenses in check. Potential disadvantages are that it can reward short-term thinking and be resource-intensive.

What are some examples of companies using zero-based budgeting? ›

Among the businesses using zero-based budgeting in 2023 and beyond include, but aren't limited to:
  • Auto manufacturer General Motors Co.
  • Industrial firm Honeywell International Inc.
  • Cosmetics business Coty Inc.
  • Chocolate maker Hershey Co.
  • Alcoholic-beverage company Diageo PLC.
Feb 24, 2023

What is the importance of having a zero-based budget quizlet? ›

Why is it important to write a zero-based budget every month? A zero-based budget is your income minus your expenses to equal zero. It is important to write a zero-based budget every month so you know how much money you have left over to spend so the budget will equal zero.

How do you pay yourself first? ›

What is a 'pay yourself first' budget? The "pay yourself first" method has you put a portion of your paycheck into your savings, retirement, emergency or other goal-based savings accounts before you do anything else with it. After a month or two, you likely won't even notice this sum is "gone" from your budget.

What are three tips for successful budgeting? ›

  • Create your budget before the month begins. To stay on top of your budget, plan ahead. ...
  • Practice budgeting to zero. ...
  • Use the right tools. ...
  • Establish needs versus wants. ...
  • Keep bills and receipts organized. ...
  • Prioritize debt repayment. ...
  • Don't forget to factor in fun. ...
  • Save first, then spend.
Feb 22, 2024

What are at least 2 advantages you see in utilizing a zero-based budget? ›

The Advantages of Zero-Based Budgeting

Alignment with strategic goals: When every line item must tie back to three to five strategic goals of an organization, the clarity on what to prioritize can be significant. Better cost control: Unsupported expenditures from prior years are called into question.

What is the major appeal of zero-based budgeting? ›

The foremost theoretical advantage of ZBB is that it offers a rational and comprehensive means to cut the budget. ZBB can be used to make different cuts to different services based on the perceived value to the organization (rational) and all spending is put under scrutiny (comprehensive).

How is zero-based budgeting different to traditional methods? ›

The biggest difference between zero-based budgeting and traditional-based budgeting is that capital isn't allocated to business units based on previous spending. Instead, zero-based budgets start at zero, with all business units inside a company competing for each dollar when the new budget is made.

What is the core characteristic that defines the zero-based budget? ›

In zero-based budgeting, your income minus your expenditures should equal zero. Savings goals, debt paydown and fun are all included.

What is zero-based budgeting for nonprofit organizations? ›

In a nonprofit, budgeting is one of the most important financial management activities – if not the most important. What Is Zero-Based Budgeting? A zero-based budget is a budget that is made from scratch every year, unlike budgets that are made using an automatic growth method.

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