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Zero-Based Budgeting (ZBB)

Source: Investopedia
This Article has been Edited for Accessibility

Zero-Based Budgeting (ZBB)

What is 'Zero-Based Budgeting - ZBB'

Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a "zero base," and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one.

Explaining 'Zero-Based Budgeting - ZBB'

Zero-based budgeting allows top-level strategic goals to be implemented into the budgeting process by tying them to specific functional areas of the organization, where costs can be first grouped and then measured against previous results and current expectations.

Zero-Based Budgeting vs. Traditional Budgeting

Traditional budgeting calls for incremental increases over previous budgets, such as a 2% increase in spending, as opposed to a justification of both old and new expenses, as called for with zero-based budgeting. Traditional budgeting analyzes only new expenditures, while zero-based budgeting starts from zero and calls for a justification of old, recurring expenses in addition to new expenditures. Zero-based budgeting aims to put the onus on managers to justify expenses, and aims to drive value for an organization by optimizing costs and not just revenue.

Example of Zero-Based budgeting

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.

Additional Resources

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