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Zero-Based Budgeting: Definition, Advantages, Disadvantages & Examples

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  • 0:05 What is Zero-Based Budgeting?
  • 0:27 The Zero-Based…
  • 1:51 Advantages of…
  • 2:46 Disavantages of…
  • 3:06 Lesson Summary
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Lesson Transcript
Instructor: Carol Woods

Carol has taught college Finance, Accounting, Management and Business courses and has a MBA in Finance.

Many companies use some form of zero-based budgeting, which is a budgeting process where no amounts carry over from prior years and no programs are considered pre-approved. In this lesson, we'll learn why companies do this and how the process works.

What Is Zero-Based Budgeting?

Zero-based budgeting is a budgeting method where every expenditure must be justified every budget cycle. When the company begins a budget process, they start from zero. Each department must request funds via a detailed plan describing what each allocation of funds will be used for and what benefits the company will receive from it.

The Zero-Based Budgeting Process

Let's say you're a manager in a company that uses zero-based budgeting. What will actually happen when the time comes to plan for next year?

The first step: you'll be asked to put together a budget for your department for the upcoming year. It will need to include all costs for your department, including salaries, travel, and supplies. You'll also need to justify these costs by explaining exactly what the company will get from those expenditures. Perhaps you'll assemble 50 cars? Or sell 20,000 widgets? Or provide financial statements each month and make sure all employees are paid accurately?

The next step: once you've turned in your budget, you'll probably be asked to present it to a group including senior management and the budgeting staff. You'll present your numbers and justification, and then you'll answer questions about the amounts you're requesting. Sometimes, companies will reduce or eliminate line items during the meeting if management doesn't feel the expenses are necessary.

The final step: once all the meetings are done, the budget staff will adjust budgets based on direction from senior management. They will then provide a final consolidation to management for approval. Once it's approved, the budget for your department will be sent back to you, and you can begin planning based on your final approved plan.

Advantages of Zero-Based Budgeting

The primary advantage of zero-based budgeting is that each cost is re-evaluated each year. Perhaps the company has cable service to its conference rooms, but now uses its broadband wireless to show videos during meetings. A company that bases its budget on prior year actual costs might continue to pay for the service, not realizing it's no longer needed. In zero-based budgeting, every expenditure is revisited, so that anything not contributing to the company's current objectives can be eliminated.

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