FINA 425- Unit 2 - Individual Project Zero-based budgeting

Assignment Details

Zero-based budgeting is intended to optimize the allocation of resources in an organization. The following video describes this approach:

• What is Zero-based Budgeting?

Zero-based budgeting is a unique technique for budgeting. It may work for some organizations but not for others.

Complete an analysis of the zero-based approach to budgeting. Include the following in your analysis:

• Define zero-based budgeting

• Provide a list of advantages and disadvantages

• Compare zero-based budgeting with other budgeting techniques

• Discuss the development of a decision package for existing and new programs and the ranking process

• Identify an organization and discuss how the entity might use this approach effectively

Zero-based budgeting

There are many times of budgets used in business management today. With the various types of budgets like operating budgets, project budgets, fixed budgets, and flexible budgets, a business can manage its finances efficiently. Every budget type has a critical role it plays in the financial allocation and management of the business. Managers need to understand every budget and when it is needed to utilize the right budgeting means to allocate the financial resources of the company (Janorkar, 2020). Apart from types of budgets, another valuable aspect of budgeting for a business is the approach used in budgeting. The approaches include top-down, bottom-up, and zero-based budgeting approaches (SOFI, 2020).

Zero-based budgeting refers to the approach where every manager will estimate their proposed expenses for a specified period as if they are performing for the first time. It is said to be a budgeting approach that looks at the organization from the start at zero. Every budget is known to start from a value of zero as the base. It means starting from scratch when making a budget and managers have to look at their expenses closely and justify them to the top management.

Advantages and disadvantages

Zero budgeting is often preferred by the managers as it helps them a lot in understanding how and where to allocate or spend their finances. Zero-based budgeting approach has both advantages and disadvantages when used in budgeting. The advantages and disadvantages brought about to impact the quality of the budgeting decision made at the end.

Advantages

One of the advantages of using this approach to budgeting is accuracy. In every budget, accuracy is very important as it can help save a lot of financial resources. Accuracy helps give the right result in expenditure and revenue of the business thus helping understand more of the business's financial status. With a zero-based approach, the manager has to start from scratch when making a budget. In this case, the manager can relook through every item that they need and identify whether it is needed or can be supplemented. This helps avoid budgeting for items that are not valuable for the business hence saving a lot of funds. They also evaluate the expenses against the expected performance through the computation of the operation costs. This helps give a clear picture of the costs against desired performance and thus the income flow. The managers hence tend to allocate costs that are much needed by the business and avoid expenditure on what might not be needed (Alamry et al., 2020).

Another advantage is the efficiency brought about by the approach. The approach allows managers to be efficient in allocating their financial resources among departments or teams. With this, every manager has made their estimated expenses from scratch and identified where they need to spend the funds. It then gives the top management a clear picture of which areas of the business will need more funds and which one can survive on a low budget. Having done it from scratch and identified where the funds are much needed, the top managers can evaluate whether the expenditure meets the expected performance and whether it is worth spending in that particular area or product. It gives an efficient and effective way of allocating financial resources based on the facts at the moment and not historical facts (McKinsey & Company, 2018).

Zero-based budgeting helps reduce redundant activities. Sometimes, a company may have redundant activities in their operation that may take up more of the budget without definite returns. When doing zero-budgeting, a manager can easily identify such activities and cancel them they could also find where to combine them in case they are similar to other activities that could improve returns if done together. As such, a manager easily identifies opportunities that are worth investing in and a cost-effective way of doing things by getting rid of unproductive activities. It needs managers to justify every expense in their departments and thus understand why every dollar should be spent. This makes them justify all the operating expenses and find which areas are generating income for the company (McKinsey & Company, 2018).

Another advantage is that it helps in budget inflation. It helps overcome the weaknesses of the incremental budgeting caused by budget inflation. Sometimes, one may find that the budget they are making keeps increasing compared to the previous years. This may be because of the errors that may be found from editing previous budgets without scrutinizing the activities. A manager needs to start from zero on making the budget so that they pick only the updated version of activities and the most needed ones at the specific time which are likely to bring returns. Redundant and unproductive activities which may cause budget inflation are done away with when using this approach. Sometimes departments will keep the budget as it is to avoid having their budget cut and enjoy having expenses growing over time to have more funds. This could cause a lot of misallocation of funds over the years which can cause adverse problems, especially during economic shocks. It is always known the best way in budgeting is to remain within the budget limit (Wei, 2016).

Zero-budgeting eases the coordination and communication in an organization regarding financial resources. During such a budgeting approach, departments enhance coordination and communication with employees where they understand which vital areas need budget allocation and which ones can be removed. Employees who also help implement thee, are involved in the budgeting decision making thus increasing the ability to scrutinize all the activities based on their performance and efficiency.

Disadvantages

Despite the approach proving to be effective, there are drawbacks to using it in the budgeting process. One of the drawbacks is it takes a lot of time. Zero-based budgeting has been known to be time-consuming as it is an intensive exercise when done in a company or a government-based entity on yearly basis. Such organizations deal with large budgets which may take a lot of time to complete thus delaying financial resource allocations. Reviewing and justifying every element of the budget is time and effort-consuming compared to modifying the existing budgets and reviewing to add new elements. Many people would claim it does not justice to the time cost experienced.

The second disadvantage is the high manpower required. To do this work, there needs a large number of employees to help compile the activities needed and justify the expenses in those activities. As such, a whole department might need to be involved in budgeting as they have to review and justify all activities from scratch while making the budget. This may delay the execution of other critical activities of the department and the organization at large.

In addition, lack of expertise becomes a challenge in such a situation where the people who can fully make the zero-budgets are limited. It involves explaining every line item and every cost that is involved which may prove difficult for some managers unless they are trained. This may cause errors in the budgeting process due to a lack of expertise.

There is also a risk of manipulation by savvy managers. Some managers can use the process to get more resources for their departments. This poses a change to the organizational culture and reduces cooperation in the company as it can easily make employees feel expendable. Some departments may be getting fewer resources while others get more and managers can end up exploiting those resources reducing employee morale.

In conclusion, the zero-based budgeting approach is effective for managers in finding proper activities to allocate financial resources. With the chance to always start from scratch managers can evaluate the effectiveness of the operation activities. It also helps in finding the revenue-generating activities of the company and separating them from unproductive activities to avoid budget inflation. This approach helps save resources by minimizing wastage. However, due to lack of expertise, time constraint, and cases of savvy managers, the approach may be misused and thus cause a lot of trouble for the company. Zero-based budgeting approach takes a lot of time and resources to review and justify all the items in the budget which makes it unused in companies and large entities despite its importance. It is, therefore, the responsibility of the managers and the employees to help embrace this approach in organizations and departments in an attempt at efficiency and effective financial resource management.

References

Janorkar, P. (2020, April 8). Types of budget [Image]. Seminars Topics. https://www.seminarstopics.com/seminar/10954/types-of-budget

Wei, J. (2016, February 27). Budgeting has only one rule: Do not go over budget - Leslie Tayne. Due. https://due.com/blog/budgeting-has-only-one-rule-do-not-go-over-budget-leslie-tayne

SOFI. (2020, January 21). 5 Different Types of Budgeting Methods. https://www.sofi.com/learn/content/types-of-budgeting-methods/

Alamry, S. J., Abbas, H., Al-Attar, Mashkour, S. & Hassan, M. (2020). Zero-Based Budget System and its Active Role in Choosing the Best Alternative to Rationalise Government Spending. 13. 2020.

McKinsey & Company. (2018, March 5). What is zero-based budgeting (ZBB) [Video]. YouTube. https://www.youtube.com/watch?v=MXYtqbHnaLo