Zero-Based Budget or ZBB is one of the most popular and efficient methods of budgeting for the management of personal or small business finances. All the expenses for each new period (a week, month, or quarter) need justification when using this method.
The process of budgeting starts at the stage called ‘zero base’. Every individual function in an organization goes through a complete analysis that helps determine its needs and management costs. Then the budget is built by keeping in mind the needs for the upcoming period. It does not matter whether the previous budget was higher or lower than the new one.
What Is a Zero Based Budget?
In simple words, a zero-based budget means that you plan for every single dollar that you earn before the month starts. This method leaves behind zero dollars unaccounted for.
Usually, you may have some money left after planning out all the necessary expenses for the month. Make sure to not leave this extra money without a plan. Submit it into your savings account or contribute it towards your debts, if any.
In a zero-based budget, all incoming money classifies as income and all outgoing money as an expense. Even the debt payments and savings classify as expenses. It follows the simple equation:
INCOME – EXPENSES = ZERO MONEY
This method is one of the simplest methods for budgeting. Its premise is easy to understand even for a layman.
A Simple Zero Based Budget Example
Let’s take an example of a manufacturing company that makes a tool and outsources the manufacturing of a specific part in that tool. Every year, the cost of the outsourced part increases by 10%.
Upon utilizing the zero-based budget formula, the manufacturing company may be forced to question the rising costs and look for a cheaper alternative. The company may even start looking at the pros and cons of manufacturing that part in-house.
It may start questioning the functions and expertise of its in-house manufacturing department. The company may layout new priorities, goals, expectations, and priorities to get down with a new perspective. Even the marketing department may shift its focus to better represent the company’s new outlook.
Other Budgeting Options
- Incremental Budgeting
Incremental budgeting requires you to take the actual figures and numbers of the previous year’s budget. You may add or subtract a specific percentage from those figures to obtain the current year’s budget.
This is a simple method of budgeting that is easily understood and utilized. This method is the best for you if your primary cost-driving factors do not alter year after year.
Incremental budgeting promotes the ‘spend it or lose it’ mentality.
- Activity-Based Budgeting
Activity-based budgeting is a form of top-down budgeting approach. It helps in the identification of the number of inputs that can support the targets set by the company.
Let us suppose that a company sets the output target of ten million dollars in the terms of revenue. Said company will need to undertake a few necessary tasks to meet this target. First of all, they will need to identify the activities that may help meet this target. Then they will need to find out the costs required to carry out these activities.
Only after this detailed analysis and planning can the company take appropriate actions for the fulfillment of the target.
- Value Proposition Budgeting
The value proposition budgeting option makes you take a few very important consideration in mind, such as;
- The total amount included in the budget.
- The monetary value of an item, product, or service to the clients, staff, or other stakeholders.
- Determining whether the item outweighs its cost in terms of monetary value.
This method of budgeting ensures that every item included in the budget delivers a monetary value to the budget. The goal behind this method is to minimize or outright eliminate unnecessary expenditures.
Which Method Should You Choose?
Every budgeting method has its pros and cons. Being a CPA professional must evaluate all the factors and determine which method is the easiest to implement. You must also consider several personal factors. Some methods are better for a business organization, while others are better suited towards determining a personal budget.
Only careful analysis and a deep understanding of the budgeting process and your goals can help you determine which method will work best for you. The zero-based budgeting method is one of the simpler methods and works best for the management of personal and small business finances.
The other three methods may also be used for personal financing, but they are more suited for business organizations.
Projecting balance sheet items, determining an operating budget, generating a cash flow statement, and figuring out a budget head are a few essentials that can help you determine which method works best for you.