Why zero-based budgeting is more effective
By Michelle Plumbtree
It’s time to begin thinking about the 2015-16 budget.
Should you wait for funding to be allocated to the technology department and try to live within that amount, whatever it may be, or take the initiative and begin developing your department’s budget even before you are asked?
We suggest the latter.
Begin working on next year’s budget even before you are asked. Plan ahead and understand what your department will need to be successful next year. You may not get the budget you request, but you will gain a better understanding of what is necessary to operate a successful department.
FCMAT suggests that you use a zero-based approach in developing your budget. In zero-based budgeting, each expenditure must be justified each year as compared to traditional budgeting, which is often called incremental budgeting, or “rollover budgeting.” Each method may have some advantages, but zero-based budgeting is preferable because rollover budgeting assumes past decisions are correct. Since spending levels are based on these decisions, you will have to live with the same allocation year after year even when they were based on inaccurate information.
To learn more about why zero-based budgeting is more effective, let’s explore these two different types of approaches in more depth:
What is Rollover Budgeting?
Traditional, incremental, or rollover budgeting takes the previous year’s budget as its starting point in developing a new document and increases or decreases the amounts to reflect changing assumptions in the new budget year. To obtain expenditure increases from the previous year, the budget manager is usually required to justify a request for additional funding. However, justification is not usually required to maintain the same level of budget because the prior year’s budget essentially is approved for the following year automatically.
The advantages of rollover budgeting include that it is simple to develop and understand, budgets are consistent from year to year, and departmental conflicts are more easily avoided since departments do not have to compete with each other on which will obtain additional funding.
The disadvantages of this system outweigh the advantages mainly because this method assumes all fiscal and department needs will stay the same, which rarely occurs, making the status quo the norm. Budget managers have no incentive to be innovative or creative or even to determine whether the prior level of services was adequate. This method also assumes that past decisions are correct even when they were not. In fact, budget managers often spend money in an approved budget even if there is no real need to avoid a year-end surplus that would result in a decrease in future-year budgets. This is often known as the “use it or lose it mentality,” which leads to wasteful spending.
What is Zero-Based or Incremental Budgeting?
Zero-based budgeting requires all expenses to be justified and have a purpose in the new budget year. Funds must be prioritized and allocated based on the greatest need. Instead of starting with the previous year’s budget amounts, every budget begins the new year at zero, and each expenditure request must first be determined to be essential before it is approved and added to the budget. As a result, there is no assumption that last year’s costs will automatically be approved for the new budget year.
Zero-based budgeting requires much more detail than rollover budgeting. Every budget line and expenditure request must be approved whether new or ongoing, and must be comprehensive, justified and complete. This process often motivates a department to identify alternatives, such as leasing or purchasing, or outsourcing or completing a project directly, if limited budget funds can be used more efficiently. Overall, departments are more accountable for their final budget.
The advantages of zero-based budgeting include the following:
Wasteful or unnecessary expenditures are identified and eliminated, allowing budgets to be redirected to more productive areas.
Limited funds are spent more wisely.
Budget managers have an incentive to look for more cost-effective methods or alternative approaches to improve operations.
Budgetary allocations are more understandable because they reflect the current reality, not past spending.
The process requires better communication in the organization about budgets and overall needs.
Costs often decrease as blanket increases are avoided.
Continuing expenditures must be justified on the basis of their usefulness and need.
The disadvantages of zero-based budgeting include the following:
It takes more time to develop the budget since all budget managers contend for the same sources of money.
Consensus is difficult to obtain.
Some expenditures are difficult to justify if they lack tangible benefits.
Commitment, preparation and a professional attitude are required to properly develop a budget.
It is not as effective without the appropriate training because of the complexity involved.
Zero-based budgeting holds budget managers accountable and often motivates staff to stay within budget since they participate in budget development. It is a systematic method, and while it may require an extensive amount of time and even research, the result is a budget that clearly more represents actual need.
If you begin using zero-based budgeting, you should be proactive to more clearly understand the needs in running a more effective technology department, and remember that this method entails a substantial amount of work. It will take time to appropriately complete and may not realize the full benefit in the first year.
One approach is to initially combine zero-based budgeting with traditional budgeting and incrementally transition to the latter method to increase understanding and acceptance among those that may be reluctant to change.
When accomplished correctly, zero-based budgeting ultimately ensures that all budgets, including that of the technology department, more accurately reflect reality; unnecessary expenditures are minimized; and understanding increases regarding what is necessary to operate a successful department.