What is zero based budgeting?

Zero based budgeting is a method companies use to create an annual budget from scratch. This approach requires each department to justify its spending on a zero-based budget rather than relying on the previous year’s budget. This means that each department must justify all the expenses incurred during the year to ensure that each dollar spent is necessary and generates value. 

Advantages

  • Increased Efficiency: By re-evaluating the budget every period, zero based budgeting ensures that only the essential costs are allocated, leading to increased efficiency and cost savings. 
  • Improved Performance: By allocating resources only to areas generating returns can help improve the performance of an organization.
  • Improves cost control: By making departments review and justify all their budget requests can help identify areas where we can save money. This can help to reduce the overall cost of the budget.

Disadvantages

  • Time-Consuming: Zero based budgeting requires a lot of time to develop and implement, as each department must develop their budget from the ground up.
  • Difficult to Implement: It is difficult for companies to switch from traditional to zero based budgeting, especially for organizations  that need to be better versed in the budgeting process.It requires a significant amount of training and resources in order to implement properly.
  • High Cost: It is expensive to implement a zero based budget because it requires a large amount of data analysis and input.

Traditional vs Zero based budgeting

Traditional

Zero based

Focuses on incremental budgeting

Focuses on budgeting from a clean slate  

Uses historical data and prior year budgets to determine future budget

Uses data and analysis to determine the budget 

Orientation is towards making an adjusted budget

Orientation is towards re-evaluating the budget  

The budget goes through incremental changes to the existing budget

All activities are re-evaluated and budgeted 

Changes to the budget are subtle 

The budget undergoes radical changes

How to create a Zero based budget?

  • Set Your Income and Expenses: The first step is to list your expected income and all of your expenses to create a zero based budget. Make sure to include any irregular or one-time expenses, such as gifts or travel.  
  • Set Goals for Your Money: Before allocating money for each expense, decide how much you want to save or invest each month.  
  • Track Your Spending: Track your spending for two to three months to get an accurate picture of your expenses to help you identify areas where you can cut back.  
  • Make a Budget: Make a budget that allocates your income to all of your expenses, including savings and investments. Make sure the total of all expenses equals your total income. 
  • Follow Your Budget: Once you have created your budget, commit to following it. Track your spending regularly to make sure you are staying on track. If necessary, adjust the budget as needed to ensure that you’re reaching your goals.

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