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Zero Based Budgeting

Government agencies at all levels are required to prepare budgets as a plan for spending taxpayer's money for a given period of time, usually one year. Most governments use some form of incremental budgeting, wherein, new costs or planned increases are added to existing budget plans. In times when revenue is scarce or program costs greatly increase, finance managers will consider starting the process from "zero" and building a budget from the ground up. The following is a description of such a process - Zero Based Budgeting.

Zero Based Budgeting is an integration of planning and budgeting into a single process with the objective of development and redeployment of a budget through scrutiny of programs. Zero Based Budgeting can be thought of as a tool for provides a process to evaluate programs. It allows for budget reductions and permits the re-allocation of resources from low to high priority programs. Finally, Zero Based Budgeting is a cost-benefit analysis for all decision-making in an organization.

The basic tenets of Zero Based Budgeting are:

• Budgeting is not accounting. It is accountability. As such it is not the exclusive responsibility of finance manager or the top executive. Zero Based Budgeting involves everyone in decision making.
• Past activities should not exist simply because they have acquired a history. They should exist if there is a need and someone takes the responsibility for justifying the need for their existence.
• Future activities must fit into the organizational objectives and strategy must pass the test of necessity and cost-benefit analysis.
• It is not the expenditure that should justify the output; it should be the output that must justify the expenditure.

Zero Based Budgeting requires each manager to:

• Establish objectives of the program consistent with organizational objectives and gain agreement on them;
• Define and devise alternative ways of achieving the objectives;
• Select the most practical and effective alternative;
• Break the chosen alternative into incremental levels of efforts;
• Assess the cost and benefits of each incremental level;
• Describe the consequences of disapproval of the activity; and
• Rank all the activities of the unit in priority order.

Formulation of Zero Base Budget steps:

1. Identification of "Decision Units"
2. Preparation of "Decision Packages"
3. Prioritization of decision packages within a decision unit.
4. Prioritization of decision packages of various decision units.
5. Allocate resources.
6. Monitor and evaluate.

• Decision Unit: Each cost center can be a decision unit. Decision units should be a particular activity or a group of activities that can be independent and meaningfully identified and evaluated. Decision units should not overlap. The decision units should be discrete entities for management purposes, e.g. sites or programs.
• Decision Package: A decision package is a document, which identifies a discrete activity, function or operation within a Decision Unit for evaluation and comparison with other activities. Each decision package should be "standalone" containing the following information:
  • Identification data - program/activity for which the package is made.
  • Objective of the decision unit.
  • Objective of the decision package.
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  • Feasibility Assessment:
    • Is the program required?
    • Is the program technically feasible?
    • Is the program operationally viable?
    • Is the program sound?
• The benefit-cost analysis:
  • Benefit /output (tangible) at existing/threshold/optimum level.
  • Tangible costs at the existing/threshold and optimum level.
  • Yearly phasing of the proposed expenditure.
  • Consequence of non-funding.
  • Alternatives considered
• Ranking /Prioritization
  The following are examples of criteria for ranking a decision package:
  • Statutory/Legally committed active programs.
  • Emergent programs arising from national events.
  • Advancement of knowledge or using innovative methods
  • Application of knowledge - proven methods for raising output.
  • Development of Technology based solutions
  • Welfare/safety issues
  • Facilitation of policy/decision making
• Funding Decisions
  Once all the decision packages have been ranked on the basis of pre-determined criteria, the funding decisions for the cost of total decision packages is made. While funding a decision package, it is necessary for management to indicate also the level at which activity/program should be carried out existing, threshold, or optimum level.
• Monitoring & Evaluation
  Since all the decision packages have to compete for funding, only those, which are most relevant to the organization, are funded. The monitoring and evaluation is done on the basis of the content and particularly the outputs described in the decision packages with fixed accountability.

by Jim Marconi, 2012