What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Zero Based Budgeting and How Does It Differ From Traditional Budgeting

Original post by Wanda Thibodeaux of Demand Media

Even companies that lean toward traditional budgeting may use zero-based budgeting occasionally.

Budgeting is a standard part of business operations, but people can approach budgeting in different ways. Two of the most-recognized approaches to budgeting are traditional budgeting -- also called incremental, line-item and historical budgeting -- and zero-based budgeting. These methods essentially are polar opposites, but each may be appropriate for your business, depending on what you intend to achieve through your budget process.

Gathering and Justification of Data

Perhaps the most significant difference between traditional and zero-based budgeting is the way you must gather and defend budget item data. Traditional budgeting is historically based, while zero-based budgeting is need-based. In traditional budgeting, you take information from the budget for the previous year or budget term. This information serves as your baseline, and items within the budget are assumed to represent the minimum cost of operations. You justify only incremental changes or the increases in item costs. In zero-based budgeting, you start from scratch every time and don't rely on any historical budget data. Your baseline thus is zero and you must justify everything, not just the incremental changes.

Time Commitment

Traditional budgeting relies on information from the previous budget period. Thus, some of the budgeting work already is done when you start the budgeting process. This, along with the fact you only have to justify incremental changes, means that you do not spend as much time completing the budget work. Zero-based budgeting takes more time because these luxuries are not possible. Some companies feel that the time commitment required of zero-based budgets make them impractical to do every budget period.

Addition and Elimination of Items

Traditional budgets depend on previous data -- that is, they assume you will need the same items in the current budget period as you did in the last one. However, this is not necessarily true. What you need can change depending on the market and your company's objectives. With traditional budgeting, it thus is harder to modify budget components. With zero-based budgeting, you can add or eliminate items as necessary because zero-based budgets are not historically based.

Complexity

Traditional budgets are relatively simple to read and prepare. Once you've established one, it's easy to continue the budget process in the future. By comparison, zero-based budgeting is much more complex. The need to justify everything requires gathering more data, all of which must be analyzed by someone with extensive knowledge of each department and their subject areas. Zero-based budgeting sometimes is so complex that it requires additional training in order to be executed properly.

Trends

Traditional budgeting puts incremental changes at the forefront of the budget construction and approval process. Because there is consistency in the baseline, looking at the incremental changes gives a company a way to track trends. This is much harder in zero-based budgeting because you cannot guarantee that the same items will be in the budget from year to year.

                   

References

About the Author

Wanda Thibodeaux is a freelance writer and editor based in Eagan, Minn. She has been published in both print and Web publications and has written on everything from fly fishing to parenting. She currently works through her business website, Takingdictation.com, which functions globally and welcomes new clients.

Photo Credits

  • Thinkstock/Comstock/Getty Images

Advertisement