The finance committee has approved an incremental budget for 2011.
The stipulation has
been added that a zero based budget must be performed every 5 years.
Zero-based budgeting is a technique of planning and decision-making which reverses the
working process of traditional budgeting. In traditional incremental budgeting, departmental
managers justify only increases over the previous year budget and what has been already spent is
automatically sanctioned. No reference is made to the previous level of expenditure. By contrast,
in zero-based budgeting, every department function is reviewed comprehensively and all
expenditures must be approved, rather than only increase. Zero-based budgeting requires the
budget request be justified in complete detail by each division manager starting from the zerobase. The zero-base is indifferent to whether the total budget is increasing or decreasing.
The term "zero-based budgeting" is sometimes used in personal finance to describe "zero-sum
budgeting", the practice of budgeting every dollar of income received, and then adjusting some
part of the budget downward for every other part that needs to be adjusted upward.
Zero based budgeting also refers to the identification of a task or tasks and then funding
resources to complete the task independent of current resourcing.
Advantages of zero-based budgeting
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Efficient allocation of resources, as it is based on needs and benefits.
Drives managers to find cost effective ways to improve operations.
Detects inflated budgets.
Useful for service departments where the output is difficult to identify.
Increases staff motivation by providing greater initiative and responsibility in decisionmaking.
Increases communication and coordination within the organization.
Identifies and eliminates wasteful and obsolete operations.
Identifies opportunities for outsourcing.
Forces cost centers to identify their mission and their relationship to overall goals.
Disadvantages of zero-based budgeting
1. Difficult to define decision units and decision packages, as it is time-consuming and
exhaustive.
2. Forced to justify every detail related to expenditure. The R&D department is threatened
whereas the production department benefits.
3. Necessary to train managers. Zero-based budgeting must be clearly understood by
managers at various levels to be successfully implemented. Difficult to administer and
communicate the budgeting because more managers are involved in the process.
4. In a large organization, the volume of forms may be so large that no one person could
read it all. Compressing the information down to a usable size might remove critically
important details.
5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates
skews the results.
Incremental Budgeting uses a budget prepared using a previous periods budget or actual
performance as a base, with incremental amounts added for the new budget period. The
allocation of resources is based upon allocations from the previous period. This approach is not
recommended as it fails to take into account changing circumstances. Moreover, it encourages
spending up to the budget to ensure a reasonable allocation in the next period. It leads to a
spend it or lose it mentality.
Advantages of incremental budgeting
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The budget is stable and change is gradual.
Managers can operate their departments on a consistent basis.
The system is relatively simple to operate and easy to understand.
Conflicts are avoided when departments appear to be treated similarly.
Co-ordination between budgets is easier to achieve.
The impact of change can be seen quickly.
Disadvantages of incremental budgeting
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Assumes activities and methods of working will continue in the same way.
No incentive for developing new ideas.
No incentive to reduce costs.
Encourages spending up to the budget so that the budget is maintained next year.
The budget may become out-of-date and no longer relate to the level of activity or type of
work being carried out.
6. The priority for resources may have changed since the budgets were originally set.
7. There may be budgetary slack built into the budget, which is never reviewed. Managers
might have overestimated their requirements in the past in order to obtain a budget which
is easier to work within, and which will allow them to achieve favorable results.