Zero Base Budgeting A and Performance Budgeting

Approaches to Budgeting

• Top-down approach– Upper management prepares budgets

and passes them down to individual departments

• Bottom-up approach– Each department supplies the data and

passes them up to the next level of management

Advantages of Cost-based• Budget is stable• Change is gradual and planned• Managers can operate on consistent basis• System is simple and easy to understand• Impact of change can be seen quickly

Disadvantages of Cost-based• No incentive to develop new ideas• No incentive to reduce costs• May become out of date• Promotes spending up to keep budget levels consistent• Priority for resources may have changed since the

budget was originally set

Zero Base BudgetingZero Based Budgeting implies that managers need to build a budget from the ground up, building a case for their spending as if no baseline existed- to start at zero.

The purpose of ZBB is to re-evaluate and re-examine all programs and expenditures for each budgeting cycle by analyzing workload and efficiency measures to determine priorities or alternative levels of funding for each program or expenditure. Through this system, each program is justified in its entirety each time a new budget is developed.

Zero-based Budgeting• Requires managers to start at zero for each budget period and

justify every input and output when developing the budget• Major Steps in the Process

– Definition of the Mission and Goals of the Organization– Identification of Cost Centers– Analysis of Each Cost Center– Ranking of Cost Centers and Evaluating Alternatives– Acceptance and Allocation of Resources– Budget Preparation– Monitoring and Evaluation

• Effective and Efficient Use of Resources to Achieve Goals

Advantages of Zero-based• Justified spending• Identifies Redundancies• Focuses use of resources• New and old projects are compared • Elimination of waste

Disadvantages of Zero-based• Costly and complex• Loss of long-term planning• Judging and Prioritizing may become political• May not be as useful in manufacturing

Cost-based vs Zero-based Budgeting

Cost-based Zero-based

Starting Point Prior period’s costs $0.00

Focus Adding to and subtracting

from last year’s budget

Evaluating each business activity

Additions Changes in inflation Individual business activities, projects,

contracts, and expenses

Subtractions Cuts from what was expected

N/A

Purpose To justify perceived needs and specify the

associated costs

of those needs

To justify and prioritize all business activities

Performance budgeting is a system of planning, budgeting, and evaluation that emphasizes the relationship between money budgeted and results expected.

Performance budgeting:• Focuses on results. Departments are held accountable to certain

performance standards. There is a greater awareness of what services taxpayers are receiving for their tax dollars.

• Is flexible. Money is often allocated in lump sums rather than line-item budgets, giving managers the flexibility to determine how best to achieve results.

• Is inclusive. It involves policymakers, managers, and often citizens in the budget “discussion” through the development of strategic plans, identification of spending priorities, and evaluation of performance.

• Has a long-term perspective. By recognizing the relationship between strategic planning and resource allocation, performance budgeting focuses more attention on longer time horizons.

Performance Budgeting

Performance BudgetingAdvantages• Forward planning is enhanced• Clear appreciation of ongoing cost of pursuing government objectives• Better management practices with the comparison of objectives with

achievements• Better public disclosure• Improves the accountability of government in general and the public

services in particularDisadvantages• Rationalizing the irrational (or highly political) process• Complete rationality involves listing of all available alternative ways

in which money could be spent