Zero-Based Budgeting: What It Is and How to Use It

What Is Zero-Based Budgeting (ZBB)?

Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. The process begins from a “zero base” and every function within an organization is analyzed for its needs and costs. The budgets are then built around what's needed for the upcoming period regardless of whether each budget is higher or lower than the last one.

How Zero-Based Budgeting (ZBB) Works

ZBB allows top-level strategic goals to be implemented into the budgeting process by tying them to specific functional areas of the organization. Costs can then be first grouped and then measured against previous results and current expectations.

Zero-based budgeting can be a rolling process done over several years with a few functional areas reviewed by managers or group leaders at a time because of its detail-oriented nature. It can help lower costs by avoiding blanket increases or decreases to a prior period’s budget but it's a time-consuming process that takes much longer than traditional, cost-based budgeting.

Zero-based budgeting is primarily used in business but it can be used by individuals and families, too.

Zero-Based Budgeting vs. Traditional Budgeting

Traditional budgeting calls for incremental increases over previous budgets such as a 2% increase in spending. Zero-based budgeting requires a justification of both old and new expenses.

Traditional budgeting also only analyzes new expenditures. ZBB starts from zero and calls for a justification of old, recurring expenses in addition to new expenditures. Zero-based budgeting aims to put the onus on managers to justify expenses. It drives value for an organization by optimizing costs, not just revenue.

Example of Zero-Based Budgeting

Suppose a construction equipment company implements a zero-based budgeting process calling for closer scrutiny of manufacturing department expenses. The company notices that the cost of certain parts used in its final products and outsourced to another manufacturer increases by 5% every year.

The company can manufacture those parts in-house using its workers. It finds after weighing the positives and negatives of in-house manufacturing that it can make the parts cheaper than the outside supplier.

The company can identify a situation in which it can decide to make the part itself or buy the part from the external supplier for its end products instead of blindly increasing the budget by a certain percentage and masking the cost increase,

Traditional budgeting may not allow cost drivers within departments to be identified but zero-based budgeting is a more granular process that aims to identify and justify expenditures. Zero-based budgeting is also more involved, however, so the costs of the process itself must be weighed against the savings it might identify.

The Bottom Line

Zero-based budgeting (ZBB) justifies all expenses for each new period. The process begins from a “zero base,” analyzing every function within an organization for its needs and costs. Budgets are then built around what's needed for the upcoming period regardless of whether each budget is higher or lower than the one before.