Companies deal with various expenses to complete the day-to-day operations of each department. The fund is allocated to the departments based on their need and the company’s goal. The process of fund allocation, otherwise also referred to as budgeting, is used at the start of each financial year. There are various methods of budgeting which can be utilised by companies and other businesses based on their objectives. Zero Based Budgeting is one of them and is the most efficient budgeting system as compared to the other fund allocation systems. Let’s dive deep into the concept of Zero Based Budgeting and understand the use cases, benefits and examples of this fund allocation system.
The inception of Zero-based Budgeting
The idea of Zero Based Budgeting was introduced in the 1970s by Peter Pyhrr. He was an account manager in Texas. He was later appointed to manage the budgetary process of Georgia. He stressed the idea that all expenses must be justified and the budget for the same should not be carried forward to the next year without proper scrutinising and justification.
Difference Between Zero-based Budgeting and Traditional Budgeting
Two types of budgeting processes are commonly used. One of them is traditional budgeting and the other is zero based budgeting. These can be defined as follows-
- Traditional Budgeting
Under this budgeting approach, the budget is carried forward from the past year to the present. If there is any increment in the budget then that particular amount is justified by the concerned department after assessing it for the current objectives of the company. The remaining amount is carried forward to the budget for the next year without any justification.
- Zero Based Budgeting
On the other hand, zero based budgeting requires the company to decide its specific objectives first and then allocate the funds to each objective and concerned department after justification. If the reasoning does not satisfy the goals of the company, the budget for the same is removed or decreased as per the circumstances. No amount, under the zero based budgeting, is carried forward for the next financial year. Every year, a new budget is prepared from the initial amount of zero. This is why it is called zero based budgeting.
Need for Zero Based Budgeting
The goals and main objectives of a company change over time. Usually, the company is established to accomplish some particular objectives. These objectives are based on the business plan. Some of these objectives need to be accomplished periodically on repeat while some of these need to reach a certain target only and then they do not matter as much as the other domains of the company matter to the growth. In this case, the budget may be misused by the departments for some less important tasks and it may fall short for other departments that need to accomplish comparatively more important tasks.
In this case, zero based budgeting proves to be the game-changer. This is the reason companies use zero based budgeting on regular periods if not annually. It helps them to drive the budget in a direction more aligned with the company's contemporary objectives. This is how zero based budgeting provides better results in less amount of money and boosts the financial efficiency of the organization.
Pros and Cons of Zero Based Budgeting
We have discussed how good it is for the financial status of the company to use zero based budgeting but there are also some cons along with the pros we have discussed. Here is a point-by-point comparison of the pros and cons of zero based budgeting-
|1||When budgets are allocated through zero based budgeting, they are more reasonable, justified and aligned with the objectives of the organisation.||It may harm the financial stability of the organisation because of the budget fluctuations in each department.|
|2||The budget reallocation eliminates the possibility of budget leaks for unnecessary expenses that do not contribute to the growth of the company.||It requires more workforce for budget allocation each year and the involvement of department managers is also required to justify the present needs of the concerned department. Which hinders productivity.|
|3||Improves operational efficiency and provides a competitive environment for the departments which works as a catalyst for growth.||It may harm the organisation’s brand and culture by compromising and cutting down the budget for relevant departments.|
|4||It boosts the revenue of the company in the short term by focusing on the high-revenue departments.||While focusing on short-term revenue, some departments with long-term goals may be overlooked while allocating budget under zero based budgeting.|
Steps To Consider While Allocating Budget Under Zero Based Budgeting
There are a few things that have to be considered while allocating budgets under zero based budgeting. The businesses may go through the following steps to streamline their budget through zero based budgeting-
- Research - Preliminary research has to be undertaken to reimagine the business based on contemporary market status and future projections.
- Identification of Objectives - The first step you need to take before the allocation of the budget is to identify your business goals. They can be short-term, long-term or based on any specific situation.
- Innovative Ways to Achieve Set Goals - Next you need to find better alternative and innovative ways to achieve the goals you set in the previous step. These ways may differ from the traditional approach and must be more efficient as well.
- Fund Arrangement - New ways for fund allocation can also be explored as the processing of budgeting itself will cost the business accounts annually.
- Defining Priorities - After the objectives are decided to work upon and the process for the same is critically analysed and justified for the budget allocation, you need to prioritise these selections and accordingly the budget must be allocated to the priority domains first.
- Cost tracking - A cost tracking mechanism can also be implemented to further empower the budgeting process by understanding the timely expenditure of the company in a structured manner.
Example of Zero-based Budgeting
You can understand the procedure of zero based budgeting through the following example. Suppose there is a film production company. It has many domains for the expenditure of the budget including the cost required for the story, set design, actors, crew, shooting, editing, and advertising. The requirements of this department may change over time. According to the current market scenario, one factor may hold more importance than the other and the budget shall be utilised accordingly. If the budget for the previous cycle was equal for all the categories, this time according to the market analysis it must be reimagined for all the categories and assigned in that manner. For example, if an actor holds a good brand image then there may be less need for the budget to spend on marketing so the budget may be reduced from marketing and increased to sign an actor with good market value.
To sum up, zero based budgeting is an innovative approach to solving budget issues in an organisation. It prioritises the current needs of the company and provides prompt solutions by rearranging the budget from a less important goal to a goal that holds more importance to achieve the short-term outcome. It also helps to reallocate funds from the departments that have achieved their one-time target and no need to have such an amount to further operate. With the benefits, zero based budgeting also comes with cons that may harm the company's reputation and stability due to the fluctuation in the allocation of budgets to different departments. Overall if utilised with due diligence zero based budgeting can be very beneficial for organisations to keep the budget in line and make it financially more efficient.
This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not corpseed, and have not been evaluated by corpseed for accuracy, completeness, or changes in the law.
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