This is a guest post from Hariharan Laxminarayan
Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a "zero base" and every function within an organization is analyzed for its needs and costs.
Zero-based budgeting is much more than
building a budget from zero. World-class ZBB efforts successfully build
cultures of cost management throughout the organization by using a structured
approach to facilitate cost visibility, cost governance, cost accountability,
and aligned incentives. Fortunately, the culture shift isn’t left to chance. We
believe that there is a proven, step-by-step approach to implementing
successful ZBB programs, and when this implementation is done well, ZBB makes
cost management a part of the way every employee works on a daily basis.
Let's say you're a manager in a company
that uses zero-based budgeting. What will actually happen when the time comes
to plan for next year?
The first step: you'll be asked to put
together a budget for your department for the upcoming year. It will need to
include all costs for your department including salaries, travel, and supplies.
You'll also need to justify these costs by explaining exactly what the company
will get from those expenditures. Perhaps you'll assemble 50 cars? Or sell
20,000 widgets? Or provide financial statements each month and make sure all
employees are paid accurately?
The next step: once you've turned in your
budget, you'll probably be asked to present it to a group including senior
management and the budgeting staff. You'll present your numbers and
justification, and then you'll answer questions about the amounts you're
requesting. Sometimes, companies will reduce or eliminate line items during the
meeting if management doesn't feel the expenses are necessary.
The final step: once all the meetings are
done, the budget staff will adjust budgets based on direction from senior
management. They will then provide a final consolidation to management for
approval. Once it's approved, the budget for your department will be sent back
to you, and you can begin planning based on your final approved plan.
Zero Based Budgeting Advantages:
Accuracy: Against the regular methods of
budgeting that involve just making some arbitrary changes to the previous
year’s budget, zero-based budgeting makes every department relook each and
every item of the cash flow and compute their operation costs. This to some
extent helps in cost reduction as it gives a clear picture of costs against the
desired performance.
Efficiency: This helps efficiently
allocation of resources (department-wise) as it does not look at the historical
numbers but looks at the actual numbers
Reduction in redundant activities: It leads
to the identification of opportunities and more cost-effective ways of doing
things by removing all the unproductive or redundant activities.
Budget inflation: Since every line item is
to be justified, the zero-based budget overcomes the weakness of incremental
budgeting of budget inflation.
Coordination and Communication: It also
improves coordination and communication within the department and motivates
employees by involving them in decision-making.
Although zero-based budgeting merits make
it looks like a lucrative method, it is important to know the disadvantages
listed as under:
Zero Based Budgeting Disadvantages:
Time-Consuming: Zero-based budgeting is a
very time-intensive exercise for a company or a government-funded entry to do
every year as against incremental budgeting, which is a far easier method.
High Manpower Requirement: Making an entire
budget from the scratch may require the involvement of a large number of
employees. Many departments may not have adequate time and human resource
for the same.
Lack of Expertise: Explaining every line
item and every cost is a difficult task and requires training the managers.
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