Zero-Based Budgeting: Benefits and Drawbacks (2024)

What Is Zero-Based Budgeting?

Zero-based budgeting is an accounting practice that forces managers to think about how every dollar is spent in every budgeting period. It can have both benefits and drawbacks.

Pete Pyhrr developed the idea of zero-based budgeting in the late 1960s to early 1970s while he was an account manager at Texas Instruments. Many Fortune 500 and private equity companies have adopted this budgeting technique since that time.

Key Takeaways

  • Zero-based budgeting differs from traditional budgeting in that the companies using it create a budget for each new period.
  • The benefits can include lower costs by keeping old and new expenses in check.
  • Potential disadvantages are that it can reward short-term thinking and be resource-intensive.
  • Zero-based budgeting can be manipulated by savvy managers.

Understanding Zero-Based Budgeting

A study from Accenture Strategy on zero-based thinking published in 2018 found that this budgeting method grew exponentially among the world's 85 largest companies at a rate of 57% each year from 2013 through 2017. These companies include Kraft Heinz Co., Mondelez International Inc., and Unilever PLC.

Companies start with the previous period's budget as a template in traditional budgeting. They then build upon it. Each new budget usually increases incrementally compared to the previous period's budget and companies only have to justify new expenses.

Zero-based budgeting deviates from traditional budgeting in that the budget for each new period is created starting from a "zero base." Companies must justify each expense before adding it to the new budget, even old and recurring expenses.

Benefits of Zero-Based Budgeting

The major advantages of zero-based budgeting are flexible budgets, focused operations, lower costs, and more disciplined execution.

Managers Must Justify All Operating Expenses

Zero-based budgeting ensures that managers think about how every dollar is spent and they must do so every budgeting period. This process also forces them to justify all operating expenses and to consider which areas of the company are generating revenue.

It Keeps Legacy Expenses in Check

Legacy costs may not be examined for years in traditional budgeting until there's some sort of economic shock that forces the company to take extreme actions. Expenses tend to grow over time with each department protecting its budget from cuts.

It can lead to significant misallocation of resources over time. Zero-based budgeting can prevent this from happening if it's done correctly.

Managers must justify all expenses with zero-based budgeting. It generally doesn't matter if the new budget is higher or lower than the one that preceded it.

Drawbacks of Zero-Based Budgeting

The disadvantages of zero-based budgeting include the possibilities of resource intensiveness, being manipulated by savvy managers, and bias toward short-term planning.

It Can Reward Short-Term Thinking

One of the major shortcomings of zero-based budgeting is that it can reward short-term thinking by shifting resources toward areas of companies that will generate revenue over the next calendar year or budgeting period. Some areas of companies that aretypically viewed as long-term investments that aren't directly tied to revenue may be left with smaller budgets than they actually need as a result.

These long-term investments can include research and development or worker training. This could potentially hurt a company because these areas are often the keys to remaining competitive over the long term but they won't be generating revenue in the near term.

It's Resource Intensive

Zero-based budgeting is also resource-intensive. It takes a lot more time and effort to closely review and justify every budget element rather than modify an existing budget and review only new elements. Some critics argue that the benefits of zero-based budgeting don't justify its time cost because of this.

It Can Be Manipulated by Savvy Managers

The process can be gamed by savvy managers to get more resources into their departments. This can lead to a change in culture. There's a decreased spirit of cooperation in the company because workers feel expendable.

What Are Operating Expenses?

Operating expenses are costs that a company incurs just to keep up and running. They don't include financing or investing. They produce revenue. They're either fixed, such as rent or mortgage payments, or they're variable, such as salaries paid to workers. Salaries can be tweaked if necessary. Mortgage payments are more carved in stone.

What Are Legacy Costs?

Legacy costs are expenditures that are associated with providing retirement and health benefits to a company's workers. They're a common expense for government employers but they're common among corporate employers as well.

Can a Zero-Based Budget Be Applied to Personal Finances?

It can and the math is really simple. Add your monthly expenses to the amount of money you'd like to save each month. Subtract the total from your monthly income. You have a zero-based budget if the result is zero or very close to it. You'll want to make adjustments if your budget is less than zero. You're in pretty good shape if it's more. Decide where you want to put that extra money.

The Bottom Line

Zero-based budgeting effectively creates a new, start-over budget for each accounting period. As the name suggests, each budget begins at zero. A focus like this can keep costs and expenses under a microscope and it can give managers more control. Opponents argue that this type of budgeting doesn't keep an adequate eye on future needs.

Business owners might want to do a trial run on paper first, at least for a little while, before jumping in with both feet and committing to the process.

Zero-Based Budgeting: Benefits and Drawbacks (2024)

FAQs

Zero-Based Budgeting: Benefits and Drawbacks? ›

Zero-based budgeting differs from traditional budgeting in that the companies using it create a budget for each new period. The benefits can include lower costs by keeping old and new expenses in check. Potential disadvantages are that it can reward short-term thinking and be resource-intensive.

What are the advantages and disadvantages of zero-based budget? ›

Advantages include efficiency, accuracy, and reducing budget inflation. Disadvantages include high manpower turnover and being time-consuming. It was adopted in India in 1983 by the Department of Science and Technology.

What are the pros and cons of no budget budget? ›

Pros and cons of a zero-based budget
ProsCons
Helps you determine where you need to trim your spendingCan require a lot of preparation and maintenance
Every dollar serves a purposeIt can be challenging to account for variable expenses
1 more row

What is good about a zero-based budget? ›

Zero-based budgeting is a way to plan how you use each dollar you earn. This budgeting style may give you greater insight into your finances and provides you the flexibility to customize your budget each month. Zero-based budgets require advance planning, particularly for those with inconsistent incomes.

Which of the following is an advantage of zero-based budgeting? ›

As an accounting practice, zero-based budgeting offers a number of advantages including focused operations, lower costs, budget flexibility, and strategic execution. When managers think about how each dollar is spent, the highest revenue-generating operations come into greater focus.

What is a drawback of zero-based budgeting? ›

Cons of Zero-Based Budgeting

Though you can implement repeatable processes with ZBB, it will most likely be more time-consuming than traditional budgeting. You're also faced with getting other departments to cooperate, and they might not be able to adequately measure their needs for the entire year.

What are three disadvantages of using the zero-based budget? ›

It Can Be Complex—and Expensive

The extra training required (including using any new software, workflows, etc.), along with the fact that each budget is built from scratch rather than relying on the (quicker and easier) data from last year can add significant expense when making the change.

Why is the zero-based budget the most effective type of budget? ›

The zero-based budget is often considered the most effective type of budget primarily due to its detailed planning and less wasteful nature. In a zero-based budget, instead of using previous budgets as a reference, every expense must be justified in every new period.

What are six disadvantages of budgeting? ›

Disadvantages of budgeting
  • a budget could be inflexible, and not allow for unexpected circ*mstances.
  • creating and monitoring a budget can be time consuming.
  • budgeting could create competition and conflict between teams or departments.
  • if targets are unrealistic, employees could become stressed and under pressure.

What are the advantages and disadvantages of budgeting? ›

Advantages & Disadvantages of Budgeting
  • Advantages of Budgeting. Improved Planning and Control. Better Resource Allocation. Enhanced Communication and Coordination. Increased Motivation.
  • Disadvantages of Budgeting. Inflexibility. Time-Consuming. Potential for Conflict. ...
  • Table comparing advantages & disadvantages of budgeting.
Jul 16, 2023

What is zero-based budgeting in simple words? ›

Zero-based budgeting (ZBB) is a budgeting approach that involves developing a new budget from scratch every time (i.e., starting from “zero”), versus starting with the previous period's budget and adjusting it as needed.

What is zero-based budgeting for dummies? ›

Zero-based budgeting is when your income minus your expenses equals zero. Perfect name, right? So, if you make $5,000 a month, everything you give, save or spend should add up to $5,000. Every dollar that comes in has a purpose, a job, a goal.

What are the advantages of zero-based budgeting quizlet? ›

Which of the following is an advantage of zero-based budgeting? Zero-based budgeting forces managers to justify each dollar in the budget to ensure that some expenses are lower in a current year compared to what they were in previous years.

Which companies use zero-based budgeting? ›

Among the businesses using zero-based budgeting in 2023 and beyond include, but aren't limited to:
  • Auto manufacturer General Motors Co.
  • Industrial firm Honeywell International Inc.
  • Cosmetics business Coty Inc.
  • Chocolate maker Hershey Co.
  • Alcoholic-beverage company Diageo PLC.
Feb 24, 2023

How zero-based budgeting is different from other methods? ›

The base of Cost requirement

In conventional budgeting, the company makes the budget by analysing the previous year's cost and takes it as a base for the new year's cost whereas in zero-budgeting, the company basically focuses on the objective of the cost and then plans accordingly to the expense.

What are the main advantages of zero maintenance? ›

Zero Maintenance is a strategy that can remove boundaries set by traditional IT management. It enables applications and systems to achieve and sustain near-zero spend, and transforms the traditional maintenance practices from “Fail and Fix” to “Predict and Prevent” and ultimately to a “Fail Proof” state.

What are the advantages and disadvantages of activity based budgeting? ›

Comparing Budgeting Approaches: Activity-Based Budgeting Advantages & Disadvantages. ABB provides valuable insights into business operations and enables better resource allocation. It comes with higher costs, a longer implementation time, and requires specialised knowledge.

What are the advantages of zero-based budgeting Wikipedia? ›

Advantages and disadvantages

Zero-based budgeting encourages companies to evaluate every department's funding, and their current needs rather than the momentum of the previous year's budget or previous expenditure. It can help remove redundant spending.

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