The A-Z of Zero Based Budgeting
Zero based budgeting is spreading like wildfire in the business world. It has made a big impact everywhere, starting from its inception in the sixties to being adopted by large companies like Unilever today.
Zero based budgeting might be a common concept today, but not many are aware of it. We take you through its history, differences and opposition to give you a full picture of what it is.
Where did zero based budgeting come from?
Zero based budgeting is the invention of Peter Pyhrr who developed it in the 1960’s. The philosophy became mainstream after a paper published by the Harvard Business Review in the seventies. It got the attention of Governor Carter who used it to reel in government spending.
But lately, it has made a big splash in the financial news. Zero based budgeting has become a cornerstone of financial plans of conglomerates like Unilever and Diageo to help build capital for investment in growth.
In traditional budgeting, changes in expenses and income are evaluated between one month, quarter or year. If for example, you’re creating a budget for your clothing business, you will create estimates for future spending based on last year’s figures and tweak based on expected changes. Managers look for variances between expenses and focus on their impact.
Where zero based budgeting differs
Zero based budgeting, in contrast to the traditional form, focuses on those expenses that are important to the business in the next time period, irrespective of their impact in the previous period. By understanding the significance of each cost in every category, financial managers can better plan their budget around fulfilling important expenses first and eliminating unnecessary costs.
This approach is a big difference from other budgets which don’t question expenditures with no variance, and instead continue to include them in their budget. Zero based budgeting questions every cost and highlights those cost that are important to the business achieving its goals. It does not forecast figures based on that of the previous year.
Criticisms of zero based budgeting
As effective as some organizations have found zero based budgeting, some parties have criticized it. The concept faces some opposition but chief among them are the following three:
- Going through each expense and not just variances is time consuming.
- Focusing only on expenses and not growth, zero based budgeting prioritizes only those opportunities that reduce cost.
- It sacrifices future development in favor of short-term gains.