Zero-based budgeting (ZBB) is a budgeting approach in which every expense must be justified from scratch, regardless of whether it is included in a previous budget or not. Unlike traditional budgeting methods, where prior budget figures are often used as a baseline for the next period's budget, zero-based budgeting starts with a "zero" base and requires all expenses to be justified and approved based on their necessity and relevance to current business objectives.
The process of zero-based budgeting typically involves the following steps:
- Identification of activities and expenses: All activities and expenses are identified and categorized, and each expense is broken down into its individual components.
- Review and justification: Managers and budgeting teams thoroughly review each expense item, questioning its necessity, efficiency, and contribution to organizational goals. They must provide a solid justification for each expense.
- Ranking of expenses: Expenses are prioritized based on their importance and alignment with strategic objectives. Essential activities and expenses are allocated resources first.
- Budget allocation: Budgets are then allocated to the activities and expenses according to the priority ranking. This is done until the available budget is fully distributed.
- Monitoring and control: Throughout the budget period, actual expenditures are closely monitored and compared to the allocated budget. Any deviations are addressed promptly to maintain budgetary discipline.
Zero-based budgeting is often seen as a way to identify unnecessary or redundant expenses and ensure that resources are allocated efficiently. It can lead to cost savings and resource optimisation, as well as encourage a thorough examination of business processes and expenses. However, it can also be more time-consuming and may require more effort compared to traditional budgeting methods. As a result, some organisations may use a combination of zero-based budgeting for certain areas and traditional budgeting for others.