ZERO BASED BUDGETING (ZBB)

A method of budgeting in which all expenses must be justified for each new period.
1. Zero-based budgeting starts from a "zero base" and every function within an organization is analyzed for its needs and costs.
  1. 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.
MERITS
1. Inefficient or obsolete operations can be identified and discontinued
2. ZBB leads to increased staff involvement at all levels since a lot more information and work is required to complete the budget
3. It responds to changes in the business environment
4. Knowledge and understanding of the cost behaviour patterns of the organisation will be enhanced
5. Resources should be allocated efficiently and economically
DEMERITS
1. Shortermism
  1. It emphasises shortterm benefits to the detriment of longterm goals.
2. Limted flexibility
  1. The budgeting process may become too rigid and the organisation may not be able to react to unforeseen opportunities or threats
    1. Since decisions are made at budget time, managers may feel unable to react to changes that occur during the year. This could have a detrimental effect on the business if it fails to react to emerging opportunities and threats.
3. Too much technical exercise
  1. The management skills required may not be present
    1. Departmental managers will not have the skills necessary to construct decision packages. They will need training for this and training takes time and money.
4. Time consuming
  1. Managers may feel demotivated due to the large amount of time spent on the budgeting process
    1. The process of identifying decision packages, determining their purpose, costs and benefits is massively time consuming and therefore costly.
5. Qualitative barriers
  1. Ranking can be difficult for different types of activities or where the benefits are qualitative in nature
    1. Ranking the packages can be difficult, since many activities cannot be compared on the basis of purely quantitative measures. Qualitative factors need to be incorporated but this is difficult.
6. Huge paper work have to be done
  1. In a large organisation, the number of activities will be so large that the amount of paperwork generated from ZBB will be unmanageable.
Without approval, the budget allowance is zero’
Steps in ZBB
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        The resources are then allocated to the various packages.
        Priority i given to high ranking decision packages when allocating the resources
      2. Ranking of the Decision packages
        Each decision package is evaluated and ranked usually using cost/benefit analysis.
        The must do activities are readily approved ,activities under the discretion of the management are ranked based on VFM from each activity
    2. Each of the individual activities is then described in a decision package.
      1. The decision package should state the costs and revenues expected from the given activity. It should be drawn up in such a way that the package can be evaluated and ranked against other packages.
      2. What is a Decison Package
        A document that identifies and describes a specific activity in such a manner that senior management can:
        (a) evaluate and rank it against other activities competing for limited resources, and
        (b) decide whether to approve or disapprove it.’
        A decision package is a document that:
        analyses the cost of the activity (costs may be built up from a zero base, but costing information can be obtained from historical records or last year’s budget)
        states the purpose of the activity
        Identifies alternative methods of achieving the same purpose
        assesses the consequence of not doing the activity at all, or performing the activity at a different level
        establishes measures of performance for the activity.
        Types of decision packages
        Mutually exclusive packages: these contain different methods of obtaining the same objective.
        Incremental packages: these divide the activity into a number of different levels of activity. The base package describes the minimum effort and cost needed to carry out the activity. The other packages describe the incremental costs and benefits when added to the base.
  2. Managers should specify, for their responsibility centres, those activities that can be individually evaluated.

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ZERO BASED BUDGETING (ZBB)

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	Created by Shahid Musthafa about 11 years ago