The conventional budgeting process does have one major disadvantage. Managers tend to prepare new budget requests by adding an incremental amount to their previous year's budget requests, rather than re-evaluating the need for things already included.
Zero-base budgeting (ZBB), in contrast, enables the organization to look at its activities and priorities a fresh. Zero-base budgeting assumes that the previous year's budget is not a valid base from which to work. It forces department managers to thoroughly examine their operations and justify their departments activities based on their direct to the achievement of organizational goals.
The U.S. Department of Agriculture was the first to use zero-based budgeting in 1960s. ZBB was adopted by Texas Instruments in 1970 and by many government and business corporations during the 1970s and 1980s.
The specific steps used in zero-based budgeting are as follows:
- Break down each of an organization's activities into "decisions packages". The decision package includes written statements of the department's objectives, activities, costs, and benefits; alternative ways of achieving objectives; plus the consequences expected if the activity is not approved. Managers then assign a rank order to the activities in their department for the coming year.
- Evaluate the various activities and rank them in of decreasing benefits to the organization. Rankings for all organizational activities are reviewed and selecting by top managers.
- Allocate resources. Budget resources are distributed according to the activities rated as essential to meeting organizational goals. Some departments may receive large budgets and others nothing at all. The principal advantage of this technique is the fact that it forces managers to plan each program package afresh. However, it demands more time and energy than conventional budgeting.