Question

David Scott has come to you. He has read recently about the benefits of zero-based budgeting and wants to know more about zero-based budgeting and whether it would be appropriate for FOL.

Required:

Prepare a memorandum to David explaining the benefits and drawbacks of zero-based budgeting. Include in your memorandum consideration of the behavioural implications of zero-based budgeting.

Answer 1

In Zero based budgeting, budgets for each new period is created starting from a "zero base", unlike traditional budgeting where you start with the previous period's budget as a template and then build upon it. Therefore zero based budgeting differs from traditional budgeting in the sense that companies create new budgets for each new period.

The major advantages of Zero based business are:

1. Improves decision making: Zero based budgeting focuses on why the expense shall be incurred instead of how much shall be incurred. This ultimately improves the decision making process and helps in achieving the goals of the organisation.

2. Optimum Allocation of Funds: Zero based budgeting helps in maximizing the wealth of the shareholders by ensuring that the resources of the organisation are effectively and effectively allocated.

3. Justification of all Operating Expenses required: managers must think about how every money spent for every budgeting period. This also requires them to consider the justification of all the expenses incurred.

4. Reduction and elimination of obsolete and redundant activities and processes: Zero based budgeting focuses on identifying optimum opportunities and cost effective ways of doing things by eliminating unproductive activities.

Some of the disadvantages of Zero Based budgeting are:

1. Time consuming: Zero based budgeting demands more time and efforts for a company to do annually as against traditional method, which is easier.

2. Requires expertise: Managers need proper training and experience for providing a reasonable explanation for every cost which is a problematic task.

3. Lacks long term vision: Zero based budgeting focuses on short term profits based on revenue generated for a particular budgeting period. Long term plans of a company are not directly linked to the revenue generated in a particular period and hence can be detrimental to the long term objectives of the company.

4. Administration and Communication of Zero based budgeting requirs coordination from various departments which end up creating many critical problems.

Behavioural implications to be considered:

1. Managers are subjected to personal bias in the ranking of the decision package.

2. Managers may develop a fear and may oppose to new ideas and changes.

3. Zero based budgeting involves lots of paper work which may tend to become monotonous for the managers.

4. Managers may tend to manipulate the zero based budgeting process to gain more funds into their departments.