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What is Zero Base Budgeting [ZBB]?



What is Zero Base Budgeting?Zero-base budgeting (ZBB), a priority—budgeting—for—resources allocation can be used by nonfinancial managers to identify, plan, and control projects and programs. It enhances effectiveness and efficiency. There is a matching of service levels to available resources. Each manager must justify a budget request in detail, beginning with the zero balance. It can lower production, service, and operating costs.

What is zero-base budgeting [ZBB]? How is the zero-base budgeting processed? This post discusses the ZBB process, its effects, activity units, decision packages, ranking proposals, and project (program) budgets. Enjoy!



What is Zero-base Budgeting [ZBB]?

ZBB is a priority form of budgeting, ranking activities such as products and services. It may be used by managers to review and analyze programs, proposals, activities, and functions to increase profitability, enhance efficiency, or lower costs. ZBB results in the optimum allocation of company resources. There exists an input-output relationship.

ZBB considers the objectives of the activity and how they are to be accomplished. The failure to fund an activity may result in adverse consequences that have to be taken into account. For example, the failure to produce a particular product may adversely effect the sales of related products in the company’s overall product line.

Managers who benefit from using ZBB include production managers, purchase managers, marketing executives, general managers and other administrative staff, engineers, research managers, personnel managers, operations research staff, attorneys, and economists. For example, ZBB can be used by marketing managers to appraise competing alternative product lines, formulate an advertising strategy, evaluate salesperson performance, and establish and monitor marketing priorities.
A cost/benefit analysis should be undertaken for each sales program in terms of staff, product, and territory. The objectives of each subunit (e.g., department, responsibility center) should be consistent with the overall goals of the company


Zero-base Budgeting Process

Zero base budgeting [ZBB] begins with a zero balance and formulates objectives to be achieved. All activities are analyzed for the current year. The manager may decide to fund an existing project at the same level as last year after the review. However, it is most likely that funding will be increased or decreased, based on new information. It is also possible that an alternative way may be used for that project, based on current cost or time considerations.

The ZBB approach sets minimum funding amounts for each major activity (e.g., product, service). Amounts above the minimum level must be fully justified in order to be approved by upper management. Each program, product, or service is looked at each year to determine its benefit. If an activity cannot be supported as having value, it is not funded. The manager is not concerned with the past but rather looks at the current and future viability. The manager, in effect, discards the deadwood. Programs with inefficiencies, waste, and anything that no longer makes financial sense are dropped.

The ZBB process involves:

  • Developing assumptions
  • Ranking proposals
  • Appraising and controlling
  • Preparing the budget
  • Identifying and evaluating decision units


Activity Units

Managers should have control over the activities in their responsibility unit. They must be thoroughly familiar with how their department functions and what resources are needed for staff and money. Activities should be detailed to show work flow.

The activity unit is an important cost element of ZBB. It is the lowest unit within the company for which a budget is prepared. An activity unit may represent a function, program, organizational unit, or line item. A manager is typically accountable for the performance of a unit. Decision units include research and development, quality control, computer services, legal, engineering, production, marketing, and personnel.

There are alternative operating modes for activity units, including centralizing the activity, decentralizing the functions, integrating the operations, expanding or reducing activities, and eliminating the function. Productivity and effectiveness measures should be utilized. The manager should consider financial information, workload, and established standards.

Measures of performance include:

  • Production control—number of manufacturing trouble spots and poor productivity
  • Quality control—number of rejections and other deficiencies
  • Regional marketing manager—number of lost accounts and reasons for their loss

Control measures include:

  • Quarterly output appraisal, using predetermined performance standards
  • Quarterly modifications to the budget, based on current information
  • Comparing actual cost and time to budgeted cost and time for variance determination


Decision units should be compared within the company, particularly those that are comparable in size (e.g., number of workers, total assets, and revenue). Priority should be given to activities that must conform to legal requirements, industry practice, or other constraints.


Decision Packages

The first major step in zero base budgeting [ZBB] is the development of decision packages for existing and new programs. The decision package contains a description of the project, specific measures, and employee responsibilities. The package includes the manager’s recommended way of producing a product or rendering a service in terms of cost and time. Alternative ways of performing the activity are also specified. For example: improving the quality will increase the cost. Further, reducing the time also may increase the cost because of overtime pay.

A decision package contains this information:

  • Description of the activity and reasons to carry it out
  • Statement of objectives and benefits to be derived
  • The plan to achieve the program
  • The priorities established
  • Cost and time estimates along with evaluation
  • Alternative methods of achieving the activity stated in cost and time
  • Measures of output
  • Resources needed, including physical and personnel support from other responsibility centers
  • Legal, technical, and operational aspects
  • Risk considerations


Decision packages must be reviewed carefully for possible deficiencies. Managers should assure themselves that the packages are complete and independent. Further, decision packages should not cross functional and organizational lines. If information is missing or packages are lumped together, misleading conclusions may be drawn.

A decision package can be either mutually exclusive or incremental. The former are alternative options, meaning that the acceptance of one precludes the acceptance of another. Incremental packages involve additional effort levels. For example, one package may necessitate 3,000 labor hours per month while another may require 3,500 hours for that month.

Decision packages may cover either a short-term or long-term period. A matching of resources with objectives is necessary. Emphasis should be placed on higher return areas. The format of decision packages should be standardized. Upper management has to approve the decision packages formulated by managers.


Ranking Proposals Conduct

In ranking proposals, upper management will rely heavily on the recommendations made by managers who have a keen knowledge of their decision units. Quantitative and qualitative factors must be considered. A cost/benefit analysis should be performed for each decision unit.

The ranking of decision packages goes in the order of decreasing benefit. The manager must identify those products or services that are the most crucial. The highest priority should be assigned to the minimum increment of service below which the unit cannot operate effectively.

Top management performs the final ranking after obtaining initial recommendations of managers within the company’s divisions, departments, and cost centers. If a manager’s recommendations are rejected, he or she should be notified why.

A dollar cutoff must be established for programs depending on budgetary constraints. For example, an 80 percent cutoff may be set, so if the programs total $1 million, only $800,000 is in available funds. The manager should also rank non-funded packages, in the event that additional funds become available at a later date.

A low-priority item may later become a high-priority one because of changed circumstances. For example, the political climate may change due to a new legislature, governor, mayor, or president. Priorities may change during the year, so adjustments may be necessary.

Different ranking techniques may be used, such as single standard, voting, and major category. Single standard is best for similar packages. All packages are evaluated based on only one feature, such as revenue, earnings, return on investment, net present value, amount saved, and cost/benefit ratio. This approach is not suitable for dissimilar packages because it may not incorporate an essential aspect, such as health and safety. Under the voting method, there is a voting committee. Each member appraises the decision packages. The packages then are discussed at the committee meeting.

The ranking is based on a committee vote. Under the major category approach, decision packages are classified into areas. Decision packages are then ranked by categories, with more important ones receiving greater emphasis. A category promising rapid growth may receive 10 times the funding of a questionable category of high risk and limited earning potential. Once fund allocation has been decided on, detailed budgets are drawn up. These budgets usually are based on incremental activities incorporated on the ranking table.


A company prepares a decision package for each product department managers wish to produce. There are 150 decision packages for all existing and proposed products. An illustration for a decision package for product A to be manufactured in Department X is presented below:

A Decision Package Example
Each of the 150 products from different departments is submitted by managers to senior management, who will appraise them. There is a budget constraint, so some products will not be funded. The decision package for product A may be flatly rejected. If approved, the manager may be able to produce it either as recommended or in one of the alternative paths. The alternative may be chosen because it involves lower cost or a faster completion date. By specifying alternatives, innovation and better methods may result.


Project (Program) Budgets

A program may be by division, department, or segment within the department. A program budget is the estimated cost of conducting an activity or function. Program activities include products or services, research and development, capital assets and facilities, maintenance, marketing, training, engineering, and government contracts. A program budget provides functions for a specific activity such as quality control and marketing research.

After a goal is identified, the program and steps to achieve that goal are specified. There is an evaluation of alternatives to ascertain the most productive and least costly manner to achieve program objectives. Resources must be allocated to programs and projects.

A project should be segregated into major activities or tasks, which should then be subdivided into specific sub-activities. Program budgeting examines the tasks needed to complete a program, the manpower required, and the time period for each activity.

Program budgeting includes planning, programming, and budgeting. It accumulates data and reviews the detailed plans. It contains a mix of resources, including staff, equipment, raw materials, and capital to achieve the desired objective within a reasonable time period. Alternatives are appraised. There is a downward progression of the decision-making process. There is an emphasis on output goals of products and services rather than input goals. The budgeting is future-oriented, examining the effect of current decisions on future results.

Program budgets are used for programs or projects of a one-time, long-term nature involving large cash outlays. Any potential problems should be anticipated. Responsibility should be assigned for particular activities. Adjustments to the plan may be required.

A cost/benefit analysis should be undertaken for programs. There should be a ranking of programs in priority order. Program interrelationships must be identified. There should be a tracing of costs to individual projects, products, services, or individuals. This may be accomplished by assigning project numbers and having staff enter code numbers into the computer when supplies are requisitioned, expenses incurred, and salary payments made.

Work packages have to be approved by segment managers. A time sheet is prepared for project activities. Estimated and actual times are compared to see if deadlines are being met. There should be a time schedule for each stage of the project. This schedule should cover the phases of planning, programming, and budgeting. Activities should be timed and scheduled, using the program evaluation and review technique (PERT). Work should be inspected at key points.


Zero-base Budgeting Effects

The manager must consider the negative effect, if any, of not accepting a proposed project. For example, if the production manager does not buy a certain type of machine, that will cause quality problems with the product.

A cost/benefit analysis must be undertaken to see if the benefits derived from zero-base budgeting [ZBB] are worth the costs incurred. Because of the costs and time required, ZBB should be conducted over a span of years (e.g., three years) instead of one year. An annual evaluation is not cost effective. ZBB is a continual process because decision packages must be revised for un-expected events.

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