Weaknesses of traditional budgeting and how ZBB differs
Traditional budgeting may also be termed incremental budgeting, where the word 'incremental' is considered to relate to the small (in relation to the total costs) changes in cost which occur in any business, year on year, as activities change. These changes are normally incremental increases, and thus traditional cost budgets often 'creep' up in amount.
The defects of the traditional approach are that while it is simple to comprehend, it often misses what budgeting should really be about: achieving today's business objectives, not just updating previous figures incrementally or marginally - at its simplest, adding 3 per cent to costs because of general inflation. Objectives or policy options considered are only those incrementally different from the base position. Therefore, the marginal values of objectives and constraints and a relatively small amount of the total cost may be subject to review, rather than the total costs being budgeted.
ZBB is a planning as well as a budgeting tool; it is the systematic expression of the business's overall and detailed objectives in quantified form. ZBB considers the need for, the amount and the priority of a spend. Only when functions, activities or projects that achieve the objectives of a business are selected might it be said that the business's budgeting system is delivering.
ZBB is meant to involve all levels of management, although some aspects of the approach could be, and often are, in operation in a 'top-down', 'dictatorial' management structure.
A common method of implementation is to have the board of a company:
- establish overall objectives for the company;
- establish detailed objectives for each division, profit centre etc (in consultation with managers);
- set outline amounts for expenditure for the period under review. With these overall budget parameters, operating managers are in a position to:
- define their detailed objectives;
- propose methods of achieving their objectives;
- cost the necessary resources;
- prioritize objectives/methods where possible.
This may not appear too different from what many companies do under conventional budgeting, and indeed it could be argued that ZBB is just good budgeting. However, there remains the distinction that ZBB starts from a zero base, a clean sheet of paper - and questions the costs and resources required to achieve all the principal and detailed objectives in a logical and prioritized manner.
As mentioned at the outset, what many companies call zero-based budgeting is really only using the concept of questioning afresh each year the need for and amount of an expense, starting from a zero base. Detailed ZBB is more than this.
The stages are as follows:
1 Split each company activity into discrete decision packages (DPs).
2 Quantify (cost or possibly revenue) and rank all DPs.
3 Logically allocate resources.
Figure 10.5 shows an example of a decision package for one activity. The terms and their meanings are as follows:
a and e Activities have to be identified and defined - cost centres or areas should not just be able to exist unquestioned. The activity is given a name or reference and described.
b Someone has to take, using the popular word, ownership of the activity and its related costs or income.
c Budgets must be formally reviewed.
d Budgets have to be based on company objectives.
e Activities have to be defined.
f Alternative approaches are invited. How more effectively and efficiently might objectives be achieved?
g Cost/revenues, suitably analysed, have to be given - the sources of the data should be stated.
FIGURE 10.5 ZBB decision analysis
h Performance measures: how achievement may be measured should be identified at the outset.
i To assist in identifying whether a cost/revenue is essential, the effect of not budgeting for it should be quantified. This also should assist with ranking activities.
j The benefits of approval should be quantified. Also, there is scope for detailing relevant, less tangible benefits; again, this may assist with ranking the activities.
k Costs (or revenues) have to be ranked in order of importance, or prioritized.
Problems in implementing a ZBB system
A Can all a company's activities be identified - is it necessary to analyse them all?
B Does the company really give ownership to individuals?
C Is it possible to set up a fair system of ranking all the various activities that are to be found throughout a company?
A fair criticism of ZBB is that if you look at and ZBB every budget throughout the organization, you will waste a great deal of time, and money.
The use of an analysis sheet (Figure 10.5) could help anyone who has to focus on what their budget is for and how it may be defined and quantified to meet their company objectives.
The principles of the ZBB approach are not new and there is often no need to carry out a detailed exercise, but many budgeting exercises could be improved by adopting ZBB techniques where appropriate.
Finally, does ZBB work?
Two short examples:
1 A company had a fleet of leased cars for staff, leased under three-year agreements. Ten years before, an employee had left after one year into a lease. The company had to keep paying the lease and the car, but at least used it as a pool car. Nine years later, when applying the ZBB concept, the accountant asked: 'Why do we have a pool car?'
2 A factory that had moved over the years from manual production and assembly to robotic work was by now almost completely automated from start to finish. The factory was fully lit and heated as there were small areas of manual work, but the majority of the space had robots, with lit pathways for engineers to walk and maintain the robots. The factory's energy bill had soared over the years. It took ZBB thoughts for someone to ask: 'Why are the lights on?' Robots can work in the dark.
ZBB concepts could help deliver your cost reduction strategy.
The principal issues with budget reports are that they are often too detailed and do not elicit clear, committed responses from budget holders.
The design of reports was considered in Chapter 9 on management accounting and internal reporting. The point was made there that often a failing of reporting is that while it is taken for granted that the recipient will respond and take action as necessary (Table 10.2), it is helpful, if not essential, that a record of the necessary action is made.
TABLE 10.2 A good management report - response is required
Best - action should follow
Zenith Discs pic Management report for the 4 weeks ended 29 March 200X
How a budget holder is meant to respond and what ensues if action does not deliver strategy depends on the culture of the organization. A prime reason for a budgeting process not delivering control and results as intended is the lack of a consistent and appropriate culture.