Zero-based budgeting is a budgeting technique that begins at zero and justifies every expenditure. It is a practice in which every function and aspect of the Budget begins from scratch or zero-base. With a fresh start in Zero-Based Budgeting each new expense has to be justified and is then analysed depending upon needs and costing, writes Business Standard.
Many businesses today are facing increasingly challenging competitive environments and are suffering from uncompetitive or unresponsive cost structures that no longer respond to traditional cost management techniques.
These companies are increasingly turning to Zero Based Budgeting to better manage costs and to unlock the ownership culture required to succeed, according to satprnews.com. Financial expert Dave Ramsey recommends a zero-based budget in which your budget accounts for every dollar of income you earn. While some people need this level of discipline, others find that type of budgeting stifling.
Giving an example, Investopedia.com writes thus: Suppose a company making construction equipment implements a zero-based budgeting process calling for closer scrutiny of the expenses in its manufacturing department. The company notices that the cost of certain parts used in its final products and outsourced to another manufacturer is increasing 5% every year.
The company has the capability to make those parts in-house and with its own workers. After weighing the positives and negatives of making the parts in-house, the company finds that it can make the parts cheaper than the outside supplier.
Instead of blindly increasing the budget by a certain percentage and masking the cost increase, the company has identified a situation in which it can either make the part or buy the part for its end products.
With traditional budgeting, cost drivers within departments may not be identified, while zero-based budgeting is a more granular process that aims to identify and justify expenditures. Since zero-based budgeting is more involved, however, the costs of the process itself must be weighed against the savings it may identify.