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Friday, June 12, 2009

Zero-based budgeting

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.[1] 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.
The term "zero-based budgeting" is sometimes used in 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. It is more technically correct to refer to this practice as "zero-sum budgeting".

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.

Advantages of Zero-Based Budgeting
1. Efficient allocation of resources, as it is based on needs and benefits.
2. Drives managers to find cost effective ways to improve operations.
3. Detects inflated budgets.
4. Municipal planning departments are exempt from this budgeting practice.
5. Useful for service departments where the output is difficult to identify.
6. Increases staff motivation by providing greater initiative and responsibility in decision-making.
7. Increases communication and coordination within the organization.
8. Identifies and eliminates wasteful and obsolete operations.
9. Identifies opportunities for outsourcing.
10.Forces cost centers to identify their mission and their relationship to overall goals.

Disadvantages of Zero-Based Budgeting
1. Difficult to define decision units and decision packages, as it is time-consuming and exhaustive.
2. Forced to justify every detail related to expenditure. The R&D department is threatened whereas the production department benefits.
3. Necessary to train managers.
4. Zero-based budgeting must be clearly understood by managers at various levels to be successfully implemented.
5. Difficult to administer and communicate the budgeting because more managers are involved in the process.
6. 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.
7. Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the results



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