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Zero Base Budgeting: An operating planning and budgeting process which required each manager to justify his entire budget in detail from scratch. Zero-base budgeting technique was used by the U.S. Department of Agriculture in 1962. Texas Instruments, a multinational company, pioneered its use in the private sector. Today a number of major companies such as Xerox, Easter Airlines and some departments of Government of India are using zero-based budgeting technique.
The technique of zero-based budgeting suggests that an organization should not only make decisions about the proposed new programmes but should also review the appropriateness of existing programmes from time to time. Such a review should particularly be done of such responsibility centres where there is a relatively high proportion of discretionary costs. Costs of this type depend on the discretion on policies of responsibility centre of top managers. These costs have no direct relation to the volume of activity. Hence, management discretion typically determines the amount budgeted. Some examples are expenditure on research and development, personnel administration, legal advisory services etc.
Zero-base budgeting, as the term suggests, examines or reviews a program or function or responsibility from scratch. The reviewer proceeds on the assumption that nothing is to be allowed. The manager proposing the activity has, therefore, to justify the activity is essential and various amounts asked for one reasonable taking into account the outputs or results or volume of activity envisaged. No activity or expense is allowed simply because it was being allowed or done in the past. Thus, according to this technique each program, whether or new existing must be justified in its entirety each time a new budget is formulated.
Zero-based budgeting involves:
- Dealing with particularly all elements of managers’ budget requests.
- Critical examination of ongoing activities along with newly proposed activities.
- Providing each manager with a range of choice in setting priorities in respect of different activities and in allocating resources.
Process of Zero Base Budgeting:
The following steps are involved in Zero-Base Budgeting:
Determining the objective of budgeting: the objective may be to effect cost reduction in staff overheads or it may be to drop, after careful analysis, projects which do not fit into an achievement of the organizations’ objectives etc.
Deciding on the scope of application: the extent to which zero-base budgeting is to be introduced has to be decided, i.e. whether it will be introduced in all areas of the organization’s activities or only in a few selected areas of trial basis.
Developing decision units: decision units for which cost-benefit analysis is proposed have to be developed so as to arrive at decisions whether they should be allowed to continue or to be dropped. Each decision unit, as far as possible should be independent of other units so that it can be dropped if the cost analysis proves to be unfavourable for it.
Developing decision packages: a decision package for each unit should be developed. While developing a decision package, answers to the following questions would be desirable:
- Is it necessary to perform a particular activity at all? If the answer is in the negative, there is no need to proceed further.
- How much has been the actual cost of the activity and what has been the actual benefit both tangible as well as intangible form?
- What should be the estimated cost of the level of activity and the estimated benefit from such activity?
- Should the activity be performed in the way in which it is being performed and what should be the cost?
- If the project or activity is dropped, can the unit be replaced by an outside agency?
After completing decision packages for each unit, the units are ranked according to the findings of the cost-benefit analysis. Essential projects are identified and given the highest ranks. The last stage is that of implementing the decision taken in the light of the study made. It involves the selection and acceptance of these objectives which have a positive cost-benefit analysis or which are capable of meeting the objectives of the organization.
The above analysis shows that zero-based budgeting is in a way an extension of the method of cost-benefit analysis to the area of the corporate budgeting.
Advantages of Zero Base Budgeting:
- It provides the organization with a systematic way to evaluate different operations and programmes undertaken. It enables management to allocate resources according to the priority of the programmes.
- It ensures that each and every programme undertaken by managers is really essential for the organization, and is being performed in the best possible way.
- It enables the management to approve departmental budgets on the basis of cost-benefit analysis. No arbitrary cuts or increase in budget estimates are made.
- It links budgets with the corporate objectives. Nothing will be allowed simply because it was being done in the past. An activity may be shelved if it does not help in achieving the goals of the enterprises.
- It helps in identifying areas of wasteful expenditure and if desired, it can also be used for suggesting an alternative course of actions.
- It facilitates the introduction and implementation of the system of “management by objectives”. Thus it can be used not only for the fulfilment of the objectives of traditional budgeting but also for a variety of other purposes.