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Understanding the Zero Based Budgeting Process

written by: •edited by: Donna Cosmato•updated: 7/26/2011

Business owners typically create a budget to determine the best way to save money. Zero based budgeting is not the most efficient way for a business to handle their finances due to the excessive documentation that is necessary for compliance. Learn how this process works.

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    Business Expenses and Forecasts

    Accounting Budgeting for business expenses typically means having a basic understanding of forecasting. This means that a business must have an idea of how much money they can anticipate earning as well as how much was previously spent.

    Business budgets must include items such as utility expenses, facilities expenses for leases, or purchasing and salaries expenses. This is why most business owners create an annual budget based on the expenses and income from the previous year.

    Generally, this allows a business owner (or a business unit) to request increases (or decreases) in their expenses based on what they anticipate doing differently than the previous year. This is completely contrary to the notion of zero based budgeting.

    The process means that every business unit (or business owner) begins their fiscal year with a balance of zero. They create a plan to spend money with the caveat that each dollar they spend must be justified by an outcome that is acceptable.

    This method of budgeting works on the theory that each dollar spent must be the result of careful and thoughtful analysis that allows the end result to justify the dollars spent. Generally, these budgets may be tied back to a larger "master" budget, but they are stand-alone financial plans that are entirely based on decisions on how to spend money.

    Who uses these budgets?

    Most companies do not use this form of budget for the simple reason that managers of each department would have to spend endless hours working on a plan and justifying that plan. In addition, they would have to constantly renew their justification for each dollar expended and provide backup documentation showing not only how the money was expended, but also what effect it had on goals. For the most part, zero based budgeting is limited to government and not for profit agencies.

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    Understanding the Pros and Cons

    Money down the drain Whenever someone is dealing with finances, a plan has to be put in place to manage expenditures. There are pros and cons to all types of budgeting challenges, and this form of budgeting bears consideration before getting started.

    Here is a sampling of some of the positive and negative aspects of using budgeting that begins with a zero balance on a regular basis.

    Communication: Most companies have an internal means of communication with managers, employees and others who may be involved in projects. Dealing with the communications aspects of this form of budgeting may require some additional training, but in the long run, it can be very beneficial for a company.

    • Pros: On the plus side, the process enforces the need for everyone to be part of the same team. Regular communication between management and team members becomes the "accepted" norm.
    • Cons: Launching a new budgeting method is likely to cause some problems initially and will require a great deal of training. Companies who do not already do a good job of communicating expectations may find this change very challenging.

    Cost controls: Generally, it is very simple to take the previous year's budget numbers, add or subtract from them and determine what will be required to make this year a success. The downside is that this does not always force department, project or division heads to evaluate their spending in relation to their outcomes.

    • Pros: This type of budgeting forces everyone to pay more attention to how they intend to invest money, time and resources. Overall, this can result in better control over costs. Resources would have to be evaluated for each portion of a project (or department) and more cost effective methods of accomplishing goals should be reviewed.
    • Cons: Unfortunately, the downside could be the number of man hours that it would take to transition from a standard operating budget to the new model. In addition, the amount of paperwork that is often required can result in great projects or programs being brought to a screeching halt because of the amount of time and resources it takes to deal with this budgeting model.

    Waste and abuse: Companies of all sizes, not for profit agencies, and government agencies all have room for improvement. Almost without fail, there are areas where dollars are wasted and budget numbers get abused. Production managers may "play" with numbers to make them fit their budgets, hours may be limited on a project to keep the numbers in line with the budget, or research may be put off until a later time to make sure that budget calculations stay in line. Starting at zero every year can help rein in this type of abuse and waste.

    • Pros: Creating a budget for a large organization or project is challenging. This type of budgeting forces someone to carefully consider each dollar they want to invest into a project or program. This type of evaluation can help eliminate fraud and abuse as it forces a department (or project) manager to examine each aspect of a program carefully and eliminate overlapping functions or outcomes.
    • Cons: One of the most frustrating aspects of this type of budgeting may be that there is no baseline that is established. Unfortunately, this may result in being unable to change course if something is not working well as the process to get the change budgeted may prove unwieldy. When there is a "measurable" outcome, this may be far easier to deal with but when there is no specific "output," this can create problems.

    These are just a few of the considerations that must be carefully evaluated before changing budgeting methods. There may be alternative ways to work on individual programs or projects including the decomposition and bottom up budgeting, which can be as effective.

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    1. Small Business Accounting Guide: How Zero Based Budgeting Will Help Add Extra Cash To Your Bank Account
    2. Accounting for Management: Zero Based Budgeting

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