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Zero Based Budgeting (1642) Views

Apr 16th
by Management Duniya

 

The term ‘zero based budgeting’ is sometimes used in the personal finance to describe the practice of budgeting every dollar of income received, and then adjusting some part of the budget downward for every other part that needs to be adjusted upward’

Zero Based Budgeting is a technique that sets all budgets to nil at the beginning of the year or period and requires from the departments that they justify all of their expenditures, not just those exceeding the budget. Money is allocated to the departments based on merit and not based on the previous year budget plus or minus some percentage such as in many traditional budgeting systems.

Zero-based budgeting is a technique of planning and decision-making which reverses the working process of traditional budgeting. In traditional incremental budgeting, departmental managers justify only increases over the previous year budget and what has been already spent is automatically sanctioned. No reference is made to the previous level of expenditure. By contrast, in zero-based budgeting, every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases. Zero-based budgeting requires the budget request be justified in complete detail by each division manager starting from the zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing.

Zero based budgeting also refers to the identification of a task or tasks and then funding resources to complete the task independent of current resourcing.

Its aim is to achieve is an optimal allocation of resources that incremental and other budgeting systems cannot achieve. Managers are asked to identify and justify their areas of work in terms of decision packages prior to starting the work.

Importance:

Zero-Base-Budgeting was pioneered in the early 60s at Texas Instruments by Peter Phyrr.

ZBB is a financial and management strategy to help policy makers achieve more cost- effective delivery of public services.

The concept of zero-base budgeting has been utilized successfully by private corporations and recommended for application to the federal budget for government use, this planning and budget techniques endeavors   to redirect efforts and funds from lower priority current programs to higher priority new programs efficiency and effectiveness, and reduce spending.

Traditionally, most government budgets have been constructed by adding to the current expenditure level such amounts as seem warranted by circumstances jurisdictions, expenditures for the coming year will exceed those of the current year.  For this reason, most attention is directed to the “increments” that have been added to this year’s expenditures to reach the proposed budget total. A major flaw in incremental budgeting is that it assumes the current year’s expenditure level is justifiable and this may not be true. It may be either too low or too high.

Zero-base budgeting, on the other hand, is a detailed and concentrated study of those activities that might be considered costly or ineffective and that continue to be funded primarily because they are never examined.

It may be useful for one or more government programs to be subjected to zero based budgeting analysis every year. In such an analysis it is not assumed that the present spending for a particular program is justified. On the contrary, the wisdom of spending any money at all on the program is examined.

An important element of this budgeting procedure is that it forces prioritization of government programs and activities. With the prospect of insufficient revenue for matching the demand of spending, it is useful for the government to have a ranking of programs and activities based on proven effectiveness as well as suggested alternatives to expensive or ineffective programs.

Steps of Zero Based Budgeting

There are two steps to the process of zero based budgeting.

The first step is to develop what is called as “decision packages”.

The second is to rank the decision packages. The decision package is a document that identifies and explains the specific and goals and objectives, measurement of performance, costs, benefits and alternative courses of action.

Ranking of decision packages is then accomplished at each management level until a comprehensive agency wide ranking is obtained. Conceptually, zero-base budgeting is a systemic logical approach to allocating resources where they will do the most good.

The Pros and Cons of Zero Based Budgeting

Zero-based budgeting requires that the existence of a government program or programs be justified in each fiscal year, as opposed to simply basing budgeting decisions on a previous year’s funding level. Zero-based budgeting is often encouraged by fiscal watchdog groups as a way to ensure against unnecessary spending. Zero-based budgeting, or some modified version of it, has been used in the private- and public- sectors for decades. Indeed, it is my understanding that the first use of zero-based budgeting in government has been tracked back to Gov. Jimmy Carter’s use of it in Georgia in the early 1970s.

As with most policies, there are both benefits and costs to be taken into account when considering zero-based budgeting. Case studies about businesses and governments that have adopted zero-based budgeting, or some hybrid of it, generally report some improvement quantitatively or qualitatively. That is, the process has either saved money, improved services, or both.

In addition to saving money and improving services, zero-based budgeting may:

Increase restraint in developing budgets;

Reduce the entitlement mentality with respect to cost increases; and

Make budget discussions more meaningful during review sessions.

On the cost side of the equation, zero-based budgeting:

May increase the time and expense of preparing a budget;

Zero-based budgeting can be useful for shaking up a process that may have grown stale and counterproductive over time. But I must offer three serious warnings.

First, the success of such a change like this hinges strongly on leadership that is dedicated to the task. If those appointed to conduct budget reviews are unwilling to truly assess every item in their budget, word will get out quickly that this new budgeting technique is more symbolism than substance. Indeed, it is incumbent upon proponents of zero-based budgeting to ensure that those reviewing the budget do not have a pecuniary interest in maintaining the status quo. Allowing people who will be most affected by the elimination of programs to conduct their own reviews may be counterproductive, since most people are quick to defend their own interests.

Second, don’t attempt to do zero-based budgeting for every department, every year. Such a move may prove impossible to manage. Instead, choose several departments and/or agencies, and rotate through every facet of state government over time. In Oklahoma, which has recently adopted zero-based budgeting, officials are applying the method to two departments and several agencies each year. Once those reviews are complete, the same departments and agencies will not see another zero-based review for eight years.

Third, ensure that each review is conducted by referencing all aspects of a department, agency or program to what its goals are. This makes the very purpose of the entity being reviewed transparent, and can increase the opportunities available for making objective measurements of a department, agency or program’s success rate.

As with most programs or reforms of programs, it must be done right, or it should not be done at all. For example, department, agency or program directors who feel endangered by this kind of scrutiny will be delighted to be placed in charge, so that they can do it wrong, waste everyone’s time, and give a cutting-edge management tool like zero-based budgeting a bad name, all at the same time.

Advantages of Zero Based Budgeting:

The budget process focuses on a comprehensive analysis of                     objectives and needs.

Planning and budgeting are combined into a single process.

Managers must evaluate the cost effectiveness of their operations in detail.

Cost awareness and management participation in planning and Budgeting is expanded at all levels of the organization. Drives Managers to find cost effective ways to improve operations.

Efficient allocation of resources, as it is based on needs and benefits.

Municipal planning departments are exempt from this budgeting practice.

Increases staff motivation by providing greater initiative and responsibility in decision-making.

Identifies and eliminates wasteful and obsolete operations.

Forces cost centers to identify their mission and their relationship to overall goals.

Drawbacks of Zero Based Budgeting:

The huge amount of work involved.

Difficult to define decision units and decision packages, as it is time-consuming and exhaustive.

In a large organization, the volume of forms may be so large that no one   person could read it all. Compressing the information down to a usable size might remove critically important details.

Modified Zero Based Budgeting:

Service-level budgeting is a modified zero-base budgeting approach.

This matches spending levels with services to be performed. Under zero-base great deal of effort can be devoted to documenting personnel and expense requirements that are readily accepted as necessary. Modified zero-base can avoid this by starting at a base that is higher than zero. An appropriate starting point for a jurisdiction might be 80 or 85 percent of current spending levels. High-priority requests above this level could be identified to restore part or all of the current year’s service.

Desirable new programs could also be considered for funding. As a result, a legislative body might be presented the choice of reducing some operations in favor of some new programs. Thus a new program might be funded out of savings incurred by reduction of an existing program. The phrase “service level budgeting” is in some cases a better description of this process.

 

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