Zero-based budgeting, or ZBB, is a rigorous budgeting process that requires every dollar of every expense to be justified even if the expense has been occurring for many years. For example, if a company has been spending $100,000 each year for the rent of warehouse space, the zero-based budgeting process assumes that nothing was spent previously. As a result, the warehousing activities must be reviewed, justified and documented before any amount can be included in the budget.
Zero-based budgeting is in contrast to more common budgeting practices that focus on the incremental change from the current expenses and current budget. In other words, under a more typical budgeting process, the $100,000 of rent expense is accepted and the focus is on whether the rent for the upcoming budget should assume an inflation adjustment of $3,000 or some other amount.
While zero-based budgeting will be far more time consuming than focusing on the incremental changes for the next budget, it can result in significant cost savings. For instance, the analysis and documentation of the warehousing activities required by zero-based budgeting could lead to a better use of space, better inventory management, etc. If those efficiencies will occur, the budget for the warehousing may need to be only $60,000 (instead of more than $100,000).
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 ZBB budgeting process to significantly reduce unneeded expenses.