Definition of Zero-Based Budgeting
Zero-based budgeting, or ZBB, is a rigorous budgeting process that requires that every dollar of every expense in the budget be justified, even if the expense has been occurring at the same level for years. In other words, instead of the common budgeting practice of accepting the past level of an expense and adjusting that amount for the new budget, ZBB starts with $0 and requires that every dollar must be justified to be included in the new budget.
Example of Zero-Based Budgeting
Assume that a company has been spending $100,000 a year for the rent of a warehouse. In the past budgets the company accepted the $100,000 of rent and focused on the amount of the increase for the next budget. This year the chief executive of the company insists that the company begin using zero-based budgeting. This means that the starting amount for warehouse rent (and every other expense) for the next budget is $0. Any budgeted expense greater than $0 must be justified.
While zero-based budgeting will be more time consuming than focusing on incremental changes, ZBB can result in significant cost savings. For instance, the analysis and documentation of the warehousing activities required by zero-based budgeting may lead to a better use of space, better inventory management, etc. If those efficiencies are achievable, perhaps the budget for the warehouse rent should be $60,000 (instead of $103,000 or more).
Zero-based budgeting was widely discussed in the 1970s for businesses and governments. Today, it is again being discussed since a few large corporations have used the ZBB process to significantly reduce unnecessary expenses.