Zero Based Budgeting Definition – Example and Importance

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Zero Based Budgeting Definition

Zero Based Budgeting Definition – “ZBB is the process of creating a budget from scratch”

In case of zero based budgeting, companies create budget without going through the facts and number related to previous year budget. Each and every activity of the business is looked upon in order to check their importance. Managers evaluate the activity and come up with a conclusion regarding whether it is worth spending money or not. Even new spending goals are set.

Here the expenses of the new budget are evaluated on the basis of the actual expenses incurred rather than just increasing a fixed rate of expenses as compare to previous year budget. This method requires that each and every activity should be justified in relation to the cost incurred in it and revenue earned from it.

In simple and short words, zero based budgeting is a method of budgeting where there are no assumptions related to previous year. Moreover, this method of budgeting relates to first identify the task or activity, then analyzing them and afterwards deciding a budget for it.

Process of Zero Based Budgeting

  1. First of all, identify the task or activity for which the entity wants to decides the budget.
  2. Now analyze various methods and ways to accomplish that task.
  3. Evaluate each and every method
  4.  Then evaluate the various sources of funds.
  5. Now allocate a budget for this activity.

Zero Based Budgeting Example

In order to understand zero based budgeting definition more clearly, let’s discuss an example.

ABC company’s budget for Marketing department for the FY 2016 was Rs. 10,00,000. Now the senior management is holding a discussion regarding what should be the Marketing department budget of this year.

Case 1 – Senior management can increase the budget by 10 percent when he is adopting a traditional method.

Case 2 – Now senior management is adopting zero based budgeting method. According to this method, each and every activity of the marketing section will be scrutinized in order to know the cost. In addition to this, cost of projects that the department will take will also be evaluated.

Importance of Zero Based Budgeting

The main idea behind adopting the zero based budgeting is to minimize the cost as well as get the clear picture of the expenses incurred while undertaking an activity. So in the end a very accurate budget is prepared.

At the same time, this type of budgeting also enhances the efficiency in allocating the resources within the organization. The best part is, it takes into consideration the actual number instead of historical numbers.

One of the great advantage of this method is that it eliminates all the redundant activities and makes the organisation a cost effective organisation.

This method of budgeting involves the employees as well. Hence it results in increasing the workers participation which create a feeling of belonging among the employees.

Related Financial Terms of Zero Based Budgeting

 

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