zero based budgeting advantages and disadvantages

As businesses face macro-economic turbulence, technology change, and shifting customer expectations, manufacturers now find the decision-making process more challenging and consequential than before.

How can these leaders boost their odds of business success? The answer lies in an unbelievable source: Zero-based budgeting or Zero-basing. 

Usually mistaken as a mere cost-cutting program, zero-basing’s goal is to instill a growth mentality- a return on investment mindset not based on cost, but on value.  

Most organizational strategies fail because of employee resistance and management misbehavior. 

So, to create a cost management culture for growth requires more than just the managers and leadership team asking the right questions. Instead, the team must know how to debate spending in order to invest where it matters. 

Here are some zero-based budgeting advantages and disadvantages to determine if it’s the right course of action for you. 

Zero Based Budgeting: What It All Means

As the name implies, zero basing is a budgeting plan where the management takes a zero base approach when preparing the budget. It is the reverse approach of the regular traditional planning method of budgeting.

Peter A. Phyrr was the first person to develop and implement zero-based budgeting. The approach grew in popularity in 1979 when President Jimmy Carter implemented it in its federal government. 

In traditional budgeting, organizations review the previous year’s budget and make a few changes based on their performance expectation.  

The managers consequently consider the previous year’s budget as the baseline to the current year’s budget. 

That’s different from Zero-Based Budgeting. Here managers must justify all expenses and not only the budget change of the previous year. 

Zero-based budgeting does not care about any base. The managers must drill down and carefully analyze each expense before they finally allocate the budget. This is called ‘need analysis.’ 

Preparing the budget on zero bases is based on the actual need of the expenses for that particular year. Zero-basing does not consider whether or not the previous budget was higher or lower than the current budget.

A Practical Example Of Zero-Based Budgeting

Let’s assume that an organization outsources the manufacturing of a key part of an item that they produce. 

Implementing the zero-based budgeting method might lead the organization to look for another alternative to produce this specific part. They might start scouting internally to check if the organization’s manufacturing department can produce the parts. 

A zero basing method could make the company question the frequent increase in the cost of the outsourced part. 

Advantages Of Zero-Based Budgeting

How does zero-base budgeting, when done the right way, improve the business’s spending decisions?

Focuses On Cost-Benefit Analysis

As mentioned earlier, zero-based budgeting only focuses on the cost-benefit relationship. It does not consider the changes in expenses or whether expenses reduced or increased.

However, it focuses on the necessary expenses and the benefits you can derive from the expense.

To prepare an effective zero basing, correct and detailed information is a must. Zero-based budgeting operates horizontally as well as vertically. Hence, it allows all management levels to partake in the organization’s decision-making process.  

Promotes An Effective Resource Allocation 

The ultimate goal of an organization is to maximize its profitability and improve the shareholder’s wealth. Zero basing helps to achieve this goal. 

Zero-based budgeting ensures that organizations are able to efficiently and economically allocate their resources. 

Detects And Discontinues All Obsolete Process

First, zero-based budgeting discovers every obsolete process of the manufacturing units or other sections of the organization. If the organization finds a process as unimportant, it would be inconsiderably scrapped. 

Discontinuing these obsolete processes can lead to better pricing, better costing, and can generally improve profitability for the organization.  

Adapt To Organizational Changes 

Because of the technological changes and advance processes, organizations usually experience a change in the underlying expenses. Hence, zero-based budgeting easily adapts to organizational changes. 

Encourages More Innovation 

Zero base budgeting can promote innovation. And when modern digital tools support zero basing, organizations can easily incorporate it into their culture.

Excellent governance, granular visibility, and cost accountability become their daily routine, rather than a yearly effort that takes a little time.  

Applicable To All Resources Not Only Indirect Costs  

Zero basing goes beyond budgets. It can help develop a built, flexible organization and leave behind silos that usually hinder growth. 

The Disadvantages Of Zero Basing

Zero basing is not without its own set of disadvantages. Some of these disadvantages include:

Can Be Highly Subjective 

It can be difficult to judge whether some expenses in the organization are essential or not. 

That’s because the benefit of these expenses is usually qualitative. You cannot measure them in numbers. 

Well, to overcome this problem, the organization should seek the help of management consultants to analyze the expenses thoroughly. 

May Affect Long Term Goals 

Remember, zero-based budgeting makes cost and benefit analysis within a particular period.  Some expenses have long term benefits that could be affected. 

The organization should list out all expenses that have a long term benefit and exclude them when making the budget. It could also show when your business is in need of some extra cash.

Managerial And Skill Conflict 

It may result in management conflicts because zero basing requires a huge amount of time and effort from the executive and managerial staff. 

Sometimes, the staff may not have the required skill to prepare zero-based budgets. The management must properly plan and involve experienced and qualified staff to partake in the process of zero-based budgeting. 

Key Points On Zero-Based Budgeting

  • Identify the objective and develop a budget and an operating plan for the subsequent year. 
  • Identify effective and alternative ways to achieve the present activity 
  • Diagnose the unnecessary activities that perpetuate the budgets. 

Is Zero-Based Budgeting Right For You

Today’s business environment is becoming more volatile, and it is not slowing down soon. Even with these, business leaders must sit down to identify zero-based budgeting advantages and disadvantages before making a decision. 

Applied thoughtfully, zero-based budgeting can be an important tool to power innovation, clarify how to invest in the right places, and, more importantly, helping to develop a growth mindset.

If after budgeting you find your business could use an extra hand, contact us today to learn more about how we can help.