ZERO - BASED

BUDGETING
DEFINITION

• The term ‘zero based budgeting’ is sometimes used in the

personal finance to describe 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 is a technique that sets all budgets
to nil at the beginning of the year or period and requires
from the departments that they justify all of their
expenditures, not just those exceeding the budget. Money
is allocated to the departments based on merit and not
based on the previous year budget plus or minus some
percentage such as in many traditional budgeting
systems.
• 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 increases. Zero-based budgeting requires
the budget request be justified in complete detail by each
division manager starting from the zero-base. The zero-
base is indifferent to whether the total budget is
increasing or decreasing.
• 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.

AIM

Its aim is to achieve is an optimal allocation of resources that

incremental and other budgeting systems cannot achieve.
Managers are asked to identify and justify their areas of work in
terms of decision packages prior to starting the work.

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IMPORTANCE

• Zero-Base-Budgeting was pioneered in the early 60s at

Texas Instruments by Peter Phyrr.
• ZBB is a financial and management strategy to help policy
makers achieve more cost- effective delivery of public
services.

• The concept of zero-base budgeting has been utilized

successfully by private corporations and recommended for
application to the federal budget for government use, this
planning and budget techniques endeavors to redirect
efforts and funds from lower priority current programs to
higher priority new programs efficiency and effectiveness,
and reduce spending.

• Traditionally, most government budgets have been

constructed by adding to the current expenditure level
such amounts as seem warranted by circumstances
jurisdictions, expenditures for the coming year will exceed
those of the current year. For this reason, most attention
is directed to the “increments” that have been added to
this year’s expenditures to reach the proposed budget
total. A major flaw in incremental budgeting is that it
assumes the current year’s expenditure level is justifiable
and this may not be true. It may be either too low or too
high.

• Zero-base budgeting, on the other hand, is a detailed and

concentrated study of those activities that might be
considered costly or ineffective and that continue to be
funded primarily because they are never examined.

• It may be useful for one or more government programs to

be subjected to zero based budgeting analysis every year.
In such an analysis it is not assumed that the present
spending for a particular program is justified. On the
contrary, the wisdom of spending any money at all on the
program is examined.

These questions are typical for analyses of this type:

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 • Is there any measurable evidence of the value of
the program under review?

• Are the goals and objectives of the program

important enough to warrant the expenditures
being made?

• What would happen if the program were not

provided at all?

• Are there other less costly and more effect

objectives?

• Where would the program fit in if all programs

were displayed in order of importance?

• Would the benefits be greater if a portion of the

funds spent on under review were used instead
for other programs?

An important element of this budgeting procedure is that it

forces prioritization of government programs and activities. With
the prospect of insufficient revenue for matching the demand of
spending, it is useful for the government to have a ranking of
programs and activities based on proven effectiveness as well
as suggested alternatives to expensive or ineffective programs.

STEPS OF ZERO- BASED BUDGETING

There are two steps to the process of zero based budgeting.

The first step is to develop what is called as “decision

packages”.

The second is to rank the decision packages. The decision

package is a document that identifies and explains the specific
and goals and objectives, measurement of performance, costs,
benefits and alternative courses of action.

Ranking of decision packages is then accomplished at each

management level until a comprehensive agency wide ranking
is obtained. Conceptually, zero-base budgeting is a systemic
logical approach to allocating resources where they will do the
most good.

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THE PROS AND CONS OF ZERO-BASED
BUDGETING

Zero-based budgeting requires that the existence of a

government program or programs be justified in each fiscal
year, as opposed to simply basing budgeting decisions on a
previous year’s funding level. Zero-based budgeting is often
encouraged by fiscal watchdog groups as a way to ensure
against unnecessary spending. Zero-based budgeting, or some
modified version of it, has been used in the private- and public-
sectors for decades. Indeed, it is my understanding that the first
use of zero-based budgeting in government has been tracked
back to Gov. Jimmy Carter’s use of it in Georgia in the early
1970s.

As with most policies, there are both benefits and costs to be

taken into account when considering zero-based budgeting.
Case studies about businesses and governments that have
adopted zero-based budgeting, or some hybrid of it, generally
report some improvement quantitatively or qualitatively. That is,
the process has either saved money, improved services, or both.

In addition to saving money and improving services, zero-based

budgeting may:

• Increase restraint in developing budgets;

• Reduce the entitlement mentality with respect to cost
increases; and
• Make budget discussions more meaningful during review
sessions.

On the cost side of the equation, zero-based budgeting:

• May increase the time and expense of preparing a budget;

• May be too radical a solution for the task at hand. You
don’t need a sledgehammer to pound in a nail;
• Can make matters worse if not done in the right way. A
substantial commitment must be made by all involved to
ensure that this doesn’t happen.

Zero-based budgeting can be useful for shaking up a process

that may have grown stale and counterproductive over time.
But I must offer three serious warnings.

First, the success of such a change like this hinges strongly on

leadership that is dedicated to the task. If those appointed to
conduct budget reviews are unwilling to truly assess every item

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in their budget, word will get out quickly that this new budgeting
technique is more symbolism than substance. Indeed, it is
incumbent upon proponents of zero-based budgeting to ensure
that those reviewing the budget do not have a pecuniary
interest in maintaining the status quo. Allowing people who will
be most affected by the elimination of programs to conduct
their own reviews may be counterproductive, since most people
are quick to defend their own interests.

Second, don’t attempt to do zero-based budgeting for every

department, every year. Such a move may prove impossible to
manage. Instead, choose several departments and/or agencies,
and rotate through every facet of state government over time.
In Oklahoma, which has recently adopted zero-based budgeting,
officials are applying the method to two departments and
several agencies each year. Once those reviews are complete,
the same departments and agencies will not see another zero-
based review for eight years.

Third, ensure that each review is conducted by referencing all

aspects of a department, agency or program to what its goals
are. This makes the very purpose of the entity being reviewed
transparent, and can increase the opportunities available for
making objective measurements of a department, agency or
program’s success rate.

As with most programs or reforms of programs, it must be done

right, or it should not be done at all. For example, department,
agency or program directors who feel endangered by this kind
of scrutiny will be delighted to be placed in charge, so that they
can do it wrong, waste everyone’s time, and give a cutting-edge
management tool like zero-based budgeting a bad name, all at
the same time.

ADVANTAGES OF ZERO-BASED BUDGETING

• The budget process focuses on a comprehensive
analysis of
objectives and needs.
• Planning and budgeting are combined into a
single process.
• Managers must evaluate the cost effectiveness of
their operations in detail.
• Cost awareness and management participation in
planning and

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 Budgeting is expanded at all levels of the
organization. Drives
Managers to find cost effective ways to improve
operations
• Efficient allocation of resources, as it is based on
needs and benefits.
• Detects inflated budgets.
• Municipal planning departments are exempt from
this budgeting practice.
• Useful for service departments where the output is
difficult to identify.
• Increases staff motivation by providing greater
initiative and responsibility in decision-making.
• 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.

CRITICISMS AND DRAWBACKS OF ZERO-

BASED BUDGETING
• The huge amount of work involved.
• May lead to micro management, offering less time
and energy for the things that really matter.
• Does it really lead to a material shift in the use of
resources?
• Difficult to define decision units and decision
packages, as it is time-consuming and exhaustive.
• Forced to justify every detail related to expenditure.
The R&D department is threatened whereas the
production department benefits.
• Necessary to train managers. Zero-based budgeting
must be clearly understood by managers at various
levels to be successfully implemented. Difficult to

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 administer and communicate the budgeting
because more managers are involved in the
process.
• 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.
• Honesty of the managers must be reliable and
uniform. Any manager that exaggerates skews the
results.
MODIFIED ZERO-BASED BUDGETING
Service-level budgeting is a modified zero-base budgeting
approach.

This matches spending levels with services to be performed.

Under zero-base great deal of effort can be devoted to
documenting personnel and expense requirements that are
readily accepted as necessary. Modified zero-base can avoid this
by starting at a base that is higher than zero. An appropriate
starting point for a jurisdiction might be 80 or 85 percent of
current spending levels. High-priority requests above this level
could be identified to restore part or all of the current year’s
service.

Desirable new programs could also be considered for funding.

As a result, a legislative body might be presented the choice of
reducing some operations in favor of some new programs. Thus
a new program might be funded out of savings incurred by
reduction of an existing program. The phrase “service level
budgeting” is in some cases a better description of this process.