Question

List and discuss the pros and cons of using zero-balance budgeting? Why type of companies or industries would benefit the most from this strategy?   

Answer 1

Zero Based budgeting

Meaning and introduction

Zero based budgeting means all the expenses are started with a zero based means each cost is to be justified in the new period and every function has to analyse its costs and need to incur the same. The budgets are made regardless of the previous year’s numbers. It is a detail oriented budget where each functional department in grouped and analysed by managers. Unlike incremental or traditional budgeting zero based budgeting also involves justification of old or recurring expenses in addition to new expenses and the onus is on the managers to justify such costs.

It is a budget from scratch. It involves re-evaluating every line item and justify the same. Budgets are calculated based on actual expenses to be incurred and not on differential basis, thus it involves changing in expenses incurred due to change in operational activity

Pros of ZBB:

1. Accuracy: Arbitrary changes to previous years’ budget are avoided and it makes every department relook each items of cashflow. Helps in cost reduction also

2. Efficiency: helps in efficient allocation of resources

3. Elimination or reduction of redundant activities: Identifies cost-effective ways of doing things by eliminating unproductive activities

4. Reduces budget inflation: As every item is justified unlike traditional incremental costing

5. Team management: increases co-ordination and communication among employees

6. Liability: The managers are liable to think about every dollar being spent and justify all operating expenses. They may also consider areas generating revenue for the company

7. Reduction of chances of dis-allocation: Legacy expenses which under traditional budgeting may not be examined for years and lead to misallocation of resources which may be prevented by zero based budgeting

Cons of ZBB:

1. Time-consuming: As it is detail oriented

2. Higher manpower required: Individuals from each department must needs attention which may not be possible

3. Lack of expertise: Functional department must not be as good decision makers

4. There are possibilities that short term revenues or outcomes may be rewarded with cost allocation and long term investments may be ignored. For example employee training may be provided with a smaller budget then required as the company may not notice any short term reward from the same but then can hurt in long run

5. There may be some savvy managers who may allocate more resources to their departments through manipulation and then lead to dis allocation and misallocation of resources to other departments creating a demotivation in employees

Companies or industries benefiting from ZBB:

ZBB may be suited to industries whose growth has stagnated and now requires cost efficiency to boost profits

Example: healthcare and hospitals who focus on eliminating unnecessary costs as they focus on affordable care for patients

Start-ups whose revenues and costs are very flexible and requires constant monitoring of budgets to keep up with the evolution

When the economy is volatile, companies with strong competitive edge to increase profitability can adopt ZBB which helps them change, innovate and grow

Consumer goods companies who are already stagnated growth and sales can eliminate selling and administrative expenses by ZBB