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Zero-based budgeting, also known as ZBB, is a systematic method of examining costs and considering alternatives when deciding how to build a budget from zero.The ZBB process can help prevent wasteful or unnecessary spending. That’s because ZBB involves a critical analysis in which budgeting decisions are made based upon what the organization finds necessary or justified.Businesses, schools, government bodies, and other organizations can use the ZBB process when planning how to allocate resources. Below we further describe ZBB and how it works.
What Is a Zero-Based Budget?
A zero-based budget is a spending plan that you create from scratch based upon careful analysis and justifiable expenditures. The zero-based budget definition literally means creating a budget from a base line of zero. Individuals, schools, governments, and small business startups can create a zero-based budget.As mentioned above, ZBB is a systematic method of examining costs and considering alternatives when deciding how to build a budget from zero. What makes a budget a zero-based budget is the deliberate act of building the budget from scratch based upon what’s justified.Understanding other budgeting methods may provide a better understanding of what is a zero-based budget. Incremental budgeting, for example, makes spending recommendations based upon current activities, and line-item budgeting can unveil spending recommendations based upon historical expenditure and revenue data.ZBB, meanwhile, requires an organization to justify spending or find alternative ways of achieving organizational objectives. The general objective of a zero-based budget is to allocate resources in the most efficient and effective manner.
How Does Zero-Based Budgeting Work
Here’s a textbook example of zero-based budgeting and how it works:
Members of your organization identify programs, activities, or “decision units” that the organization could implement, such as after-school programs.
Members of the organization then prepare a “decision package” explaining the goals or objectives of the proposed programs. They also explain why the programs are necessary and how the programs could be implemented in different ways.
Members of the organization rank the proposals in descending order of importance and refer them to a higher level of management.
Top members of the organization make a final ranking decision on the budget proposals and allocate resources in the most efficient manner.
There’s no guarantee these programs will be continued in the next budget cycle, because ZBB starts from zero regardless of current or past activities.
Pros and Cons of ZBB
Here are some pros and cons of ZBB:
Pros of ZBB
Cons of ZBB
Helps prevent wasteful spending
The budgeting process can be time-consuming and labor-intensive
Programs, activities, and spending proposals are ranked by priority
Starting a budget from zero can be difficult or impractical for large organizations
Can promote effective and efficient business practices
May discourage organizations from proposing major initiatives
Encourages organizations to explore alternative ways of achieving organizational goals
It can force organizations to consider alternative plans that may not produce the best outcome
Example of a Zero-Based Budget
An example of zero-based budgeting is when San Diego implemented a ZBB pilot process for its fiscal year 2017 budget. The San Diego Performance and Analytics Department (PandA) and Facilities Services Division thoroughly examined their programs using zero-based budgeting.ZBB in this case required some of San Diego’s local government to prioritize city programs and present supporting documentation as justification. San Diego faced challenges with data collection and ultimately abandoned ZBB after seeing the results of the pilot program.
Zero-Based Budgeting vs Other Methods
The below table compares zero-based budgeting with other budgeting methods:
ZBB
Incremental budgeting
Outcome-focused budgeting
Line-item budgeting
The starting point is zero
Last year’s budget is the starting point
The organization starts by determining how much revenue it has available
Budget planners may begin the process by reviewing historical budget data and trends
Each item in the budget must be justified
Budget planners do not necessarily have to justify every item in the budget
The organization makes budget allocation decisions based on how it can best meet its goals and objectives
The organization makes budget allocations by category and enjoys flexible control over spending
Starting a Zero-Based Budget
Here are some tips for starting a zero-based budget:
Go through the process thoroughly and properly
Understand that ZBB is about building a budget from the ground up
Put the necessary time, effort, and energy toward reviewing all proposed budget items
Be willing to cut proposed budget items if you determine it’s in the organization’s best interests
Consult with members of your organization when making budget allocation decisions
Consider the goals, objectives, and financial projections of the organization when planning or finalizing the budget
The Takeaway
Zero-based budgeting can be a powerful tool for preventing wasteful or unnecessary spending. Starting from zero and requiring justification for all budget allocations may minimize your costs.Developing a zero-based budget can be time-consuming and labor-intensive, so you may want to carefully weigh the pros and cons to determine whether ZBB is right for you or your organization.
An emergency fund is a key financial safety net. Aim to have three- to six-months worth of living expenses tucked away in a separate account that earns interest, but allows you to access the money if needed (such as a high-yield savings account).
To set up a simple monthly spending budget, consider the 50/30/20 rule. This involves splitting your after-tax income into three categories of spending: 50% on needs, 30% on wants, and 20% on savings.
Frequently Asked Questions
When is zero-based budgeting used?
Is zero-based budgeting hard?
Who developed zero-based budgeting?
Photo credit: iStock/DjordjeDjurdjevic
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About the Author
Sulaiman Abdur-Rahman
Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and served as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.
