Incremental Budgeting – Zero Based Budgeting

 What’s it all about?

Different approaches to calculating next year’s budget once you have a budget set up for this year.

Incremenatal Budgeting

This is what normally happens. This year’s budget is based on last year’s budget and/or activity with extra (incremental) amounts added for the new budget period for such things as inflation, wage rises, planned increases in sales price , activity etc.

Zero Based Budgeting (ZBB).

With ZBB, the budgeting process starts from a base of zero (£0), with no reference being made to last year’s budget or actual performance. All the budget headings therefore start with a literally £0 balance.

Watch this.

Just to remind you, there is coverage of Zero based Budgeting in the videos on the Budgeting page.

Further reading.

Using ZBB to reduce costs can mean redundancies.

“The budget approach forces managers to justify every expense anew each year. That’s different from companies that use the previous year’s budget as a baseline for cuts or increases.”

Clearly using ZBB we are trying to justify every bit of expenditure. If it’s not justified then it should go. That does mean jobs sometimes.

A government adopting Zero Based Budgeting.

“The Federal Government is planning to use a zero-based budgeting format for its 2016 budget planning, Vice President Yemi Osinbajo has said.”

Illustrates the expected benefits of ZBB.

Why Zero Based Budgeting is now being used more.

“While finance executives and senior management in commercial and public sectors have applied zero-based budgeting over the decades, it has generally lacked the rigor required to maintain cost-management discipline over the long term because it was not an ongoing process. And strategies that drove cost cutting were not necessarily connected with strategies for where and how to reinvest the funds to help the enterprise grow.”

Report advocating greater use of Zero Based Budgeting:

Download the PDF file .

Report on Closed Loop Management – “Closed-loop Cost Management involves helping to achieve full visibility on all operating spend—across business units, categories and geographies to a detailed level—and exploring how the money can be spent more wisely to add value and help drive growth.”  this method uses Zero Based Budgeting. At this link:

Download the PDF file .

As the author says:

Budgeting from zero each year helps to remove unnecessary cost and create a detailed forecast. Zero-based budgeting (ZBB) can fuel growth by freeing up capital that can then be turned to more lucrative activities.”

Article on the differences between Incremental and Zero Based Budgeting.

How do we get the ‘increments’ for incremental budgeting?

When doing incremental budgeting you could adjust whole parts of your budget by the same percentage. better would be to apply rates appropriate to each particular line of the budget. Many industries maintain indices which can be used to see how costs have changed and be used for prediction and better budgeting. Here’s one.

Job advert for Zero Based Budgeting

Gives an indication of the work involved. Advert from December 2016

“We are looking for an analyst who has experience with Zero Based Budgeting to work with a FMGC client.

Key skills:

  • At least 2 years’ experience in Cost reduction focussed ZBB projects
  • Financial cost modelling and advanced analytical tools/skills
  • Specialist in modelling ZBB business case and ‘Visibility cube’ using transactional PO/AP/GL/P&L data for transparency into ‘who-spends-how-much-on-what’
  • Experienced PB&F (i.e. financial planning, budgeting, forecasting and analysis) professional
  • Advanced understanding of financial concepts such as Chart of Accounts (CoA), General Ledgers and P&L measures

Prefered experince in;

  • Indirect Procurement and Spend Analytics
  • In Manufacturing, Consumer Products, Foods or Retail Industry sectors”

Possible Written Questions.

(No indication of marks – the more marks a question gets, the more you are expected to write – detail that is, not just words!) If you can’t answer these, you need to do some more reading. I do ‘find’ questions elsewhere, so these aren’t all questions I have used myself.

Distinguish between Incremental and Zero Based Budgeting.

Describe the stages involved in implementing Zero Based Budgeting.

Critically evaluate the advantages and disadvantages of 1) incremental budgeting, 11) Zero Based Budgeting.