Zero-Based Budgeting

A budgeting process where a new budget is developed from scratch.

Author: Kevin Henderson
Kevin Henderson
Kevin Henderson
Private Equity | Corporate Finance

Kevin is currently the Head of Execution and a Vice President at Ion Pacific, a merchant bank and asset manager based Hong Kong that invests in the technology sector globally. Prior to joining Ion Pacific, Kevin was a Vice President at Accordion Partners, a consulting firm that works with management teams at portfolio companies of leading private equity firms.

Previously, he was an Associate in the Power, Energy, and Infrastructure Investment Banking group at Lazard in New York where he completed numerous M&A transactions and advised corporate clients on a range of financial and strategic issues. Kevin began his career in corporate finance roles at Enbridge Inc. in Canada. During his time at Enbridge Kevin worked across the finance function gaining experience in treasury, corporate planning, and investor relations.

Kevin holds an MBA from Harvard Business School, a Bachelor of Commerce Degree from Queen's University and is a CFA Charterholder.

Reviewed By: David Bickerton
David Bickerton
David Bickerton
Asset Management | Financial Analysis

Previously a Portfolio Manager for MDH Investment Management, David has been with the firm for nearly a decade, serving as President since 2015. He has extensive experience in wealth management, investments and portfolio management.

David holds a BS from Miami University in Finance.

Last Updated:November 21, 2023

What Is Zero-Based Budgeting (ZBB)?

Zero-based budgeting is a budgeting process where a new budget is developed from scratch. It emphasizes allocation based on efficiency and necessity, unlike the conventional ones that start based on budgetary history.

Zero-based budgeting, or ZBB, is defined as the methodology of budgetary processes that accounts for various expenses to justify their needs.

The term in itself implies the value 'zero'. This doesn't refer to the value of the budget to be zero but with the start of the budgetary processes from the foundational base of zero. 

The cost-effectiveness starts from the valuation of the needs and expenses from the amount or intensity of its requirements. Modeling is a far more complicated and time-consuming process.

It offers more clarity and a sense of effectiveness. Its contemporary estimation works on deriving maximum profits or revenues.

In the methodical imputations and calculations, budgets are designed based on needs for the forthcoming years. It is not based on the previous budgets.

The methodology is rather complicated based on the computerized data of estimations. It is derived from specific aspects focused on the profit centers.

The strategies are based on goal-oriented estimations, calculations, and budgetary allocations. These are tied to the functional aspects of the institutions in which the costs are assigned, categorized, and measurement is calculated.

The detailed orientation allowed cost estimations and imputations presenting the base zero budgeting processes.

Zero-based Budgeting Features

The institutions' focus has been on financial planning and budgeting processes. In the midst, the process of rebuilding is a wreckful affair. The question remains whether ZBB adds some credentials and value. The method of starting the ground up from zero can induce nightmares. 

The last resort remains to keep the financial boards clean and start from scratch. This brings the contemporary concept of zero-based budgeting into application and play.

The ZBB has the following features:

  1. The expenses are justified for every new period

  2. The new budgetary allocations are created for renewal according to the tenure

  3. The method helps in tackling the low costs of transactions

  4. The two methods of tracking expenditures include traditional budgeting and zero-based budgeting

  5. The budgeting process starts from base zero, where each transaction is analyzed for its transaction and cost

  6. The budgets are designed on the grounds of needs, irrespective of the order and value

The businesses function on the grounds of strategies and goals. These channel into the process of budgeting by tying these goals to functional areas of the institution. The costs are grouped into categories, and measurement is based on previous analysis and results.

This is kept in the loop with the current targets and expectations. The process is rolling over the years, with the review done periodically. Budgeting is instead a time-consuming process, unlike traditional cost-based budgeting.

Zero-based budgeting vs. traditional budgeting

ZBB can find places in the achievement of direct revenues of production. The contributions are often more justifiable in the areas of production than in services or research and development.

 Its practices are seen in businesses, by individuals, and families too. The origins can be traced to the 1960s by the former Texas Instruments account manager Peter Pyhrr. 

In traditional budgeting, the processes are repeated, like increases in regular periods. The zero-based budgeting changes are based on the needs and requirements analysis. The purpose is the need for justification of values in the study of the costs and expenses. 

The aim is to drive the value for an organization, focusing on optimizing costs and not just revenue. 

It assumes a popular methodology that starts from assumptions based on budgeting as zero. It happens to be a contemporary yet popular methodology of accounting and budgeting.

Difference between Traditional and Zero-Based Budgeting
Criteria of Classification Traditional Budgeting Zero-based Budgeting
Conceptual understanding The Budgeting method starts from the previous expenditure. This implies from the name itself, starts from the base zero.
Methodology It adopts a simple methodology with historical information based on the previous year’s expenditure. It's more complex in nature based on each item considered a new economic appraisal.
Preference and Purpose It illustrates cost ineffectiveness and is preferred by all departments. The purpose is to bring cost-effectiveness and is mostly applied by the profit centers of the institutions.
Orientation It is based on accounting processes. It is based on the processes and units of production.

Zero-Based Budge in Accounting

The accounting practices of ZBB have offered various perils, promises, and pitfalls. The benefits include the operational processes being more streamlined. It involves low costs of operations. The budget provides more flexibility and has strategic execution motives and methods. 

The managers emphasize every expense incurred around the highest means of revenue generation, operations, and standards. The growth of budgeting processes often allows the scope of misallocation of resources, preventing means of optimization and distribution.

The methodology has various pitfalls. This is done timely and has more resource-intensive techniques. The new project is developed periodically, yet the time costs are avoided. The allocations are done in an optimized manner, ensuring the highest revenues possible. 

This is done keeping in mind the short-term perspectives. This often looks ignored in the processes of research and development.

The Budgeters can apply ZBB processes to various aspects. These include multiple types of costs, namely: capital expenditures, operating expenses, sales, and administrative fees, marketing costs, variable distribution, and costs of various goods sold.

How does Zero-based Budgeting occur?

This occurs when:

Income - Expenditures = 0

For every period. 

ZBB, or Zero-sum budgeting, works on deriving a net value of zero with some purpose.

It largely works on the allocation of money into expenses, savings, and debt payments. 

In the illustration; a numerical example is presented with the idea of household expenses with earnings of $1000 periodically. 

Numerical Example
Accommodation Expenses $450
Essential Groceries $250
Dining $100
Entertainment $50
Insurance and Emergency Funds, Retirement Investment $50
Payments   $100  
Amount Left $0

The essential steps in ZBB work simply and realistically. It brings usage in various areas of households and institutional applications. 

  1. Awareness, knowledge, and clarity on the sources and amount of earnings. 
  2. Records the number of transactions or expenses incurred periodically. 
  3. Categorization or Classification of expenses. 

The calculation on the grounds of needs or parameters of requirements occurs for every new period. This doesn’t have any reliance on the budget estimated for the previous period. In conventional budgeting, the forecasts are based on the previous expenditure.

Example of Zero-Based Budgeting

In the executive organ of the government, the planning ministry sets targets based on urgent needs. It doesn't check and design the budget according to previous inclinations and implications. It doesn't carry the prior term balances and starts with zero bases.

Zero-based budgeting in India was brought in in 1983 by the Department of Science and Technology. In the 1980s, by the end of the decade in 1986, the budgetary system was implemented. This determined the expenditure budget.

Various ministries needed to start the review activities and accordingly make the expenditure estimations based on the conceptual background of zero-based budgeting.

The need to justify the essentials of every aspect of the budgeting process creates more efficiency and accountability, leaving no room for escape. It provides an alternative to estimating and allocating resources that are limited in quantity. In review, ZBB is seen as impractical and unrealistic. 

The Covid-19 pandemic created business uncertainties and an environment of dismissals. This shifted towards ZBB, making the means of savings by cutting vital costs and focusing on effective strategies.

The disruptions caused in the businesses due to the pandemic led to new avenues. This resulted in various new challenges. This led to pressures on the budget in the supply chain. 

This led to a cut in the costs to remain afloat and manage their working capital requirements. This allows them to maintain efficiency in the short term. Also, it boosts liquidity. 

The transformation of ZBB amid the pandemic has transformed the perception of the entire methodology. 

Zero-Based Budgeting Advantages and Disadvantages

Some of the advantages and disadvantages are:

  1. The cost-saving affair of the entire budgeting process is offered by ZBB. The costs, visibility, and optimization are based on priorities and needs. It offers an expanded vision to allocate, optimize, and distribute resources to fulfill the needs of the institutions. 

  2. It works as an energy savings affair despite the complicated structure and methodology. It works on the process designed that eases the budgeting experiences, setting the priorities on the business units and divisions. It places importance on the priority centers of allocation. 

  3. Structural classification provides ease and foundation. Traditional budgeting works on the set parameters of evaluation by the previous period’s expenses. This is a setback where the former dispels the set parameters of allocation and sectoral divisions. 

  4. The disadvantage lies that it is not always preferable to work with a zero base in the budgeting process. The contemporary relevance seeps into the value and supply chain structure. This makes the implementation process tedious if the priority centers have seeped into the problems of corruption or black money. This makes the bail-out process offered by the budgeting process far more challenging and strenuous.

  5. The difference lies in the theoretical background and the ZBB processes in reality. In theory, ZBB seeps from the accounting preferences and budgeting practices that allow for the discomfort of transactional and operation costs. This makes the urgent preferences of ZBB, yet the theory, in reality, offers challenges. 

  6. The perks revolve around the strategic direction of the businesses provided by ZBB. The strategic moves direct the execution of the entire budgeting processes and actions along with the remedial measures offered by the planning and allocation divisions.

Zero-Based Budgeting FAQs

Free Excel Crash Course

Sign Up for our Free Excel Modeling Crash Course

Begin your journey into Excel modeling with our free Excel Modeling Crash Course.

Learn More

Researched and Authored by Anannya Sahani 

Reviewed and Edited by Sakshi Uradi | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: