Definition: Zero Based Budgeting, also called ZBB, is the process of creating a budget from nothing without using the prior year’s budget or spending numbers. No activities are assumed to be untouchable. All expenses are judged and must be justified in order to remain in the budget.
What does zero based budgeting mean?
What is the definition of zero-based budgeting? Essentially, the management must start from scratch and look at every operation and every activity to determine whether it is worth spending the company’s money. The management must also set completely new spending goals.
Let’s take a look at an example.
Example
Every business uses budgets to curve spending and accomplish financial goals. These budgets are often based on the previous year’s budget and spending figures. This makes sense for managers looking for a benchmark to set spending goals. They can easily look at the prior year’s budget and adjust it a few percentage points up or down.
Sometimes companies’ budgets and spending are so out of control that entire company cost structure needs to be reviewed. In this case, it doesn’t make sense to look at last year’s budget. The entire budget needs to become completely redone. This kind of drastic change is referred to as a zero-based budget.
Let’s assume that Bill’s construction company is struggling to makes ends meet. Bill has no idea where his company is losing money, so he decides to start analyzing every aspect of his business. This is commonly called starting at a zero base.
Bill doesn’t use last year’s activities as a benchmark for this year. Instead, he looks at the current year’s numbers to see where costs can be cut and what can be run more efficiently. Based on what Bill’s analysis turns up, he will create a budget and allocate funds to each department and activity according.
Although this method of budgeting is much more time consuming than continuous budgeting, it allows management to see operational problems that might not have been uncovered.
Summary Definition
Define Zero Based Budgeting: Zero-based budgeting is the method of developing a budget from scratch, or “zero base”, by examining every cost and expense to see if they are essential to the company’s operations without regard to prior years’ activities.
