Dada Adefolami

Benefits of ZBB:

The benefits of ZBB are substantial. They would have to be otherwise no organization would ever go to the lengths detailed above in order to implement it. These benefits are set out below:

1. Since ZBB does not assume that last year’s allocation of resources is necessarily appropriate for the current year, all of the activities of the organization are re-evaluated annually from a zero base. Most importantly therefore, inefficient and obsolete activities are removed, and wasteful spending is curbed. This has got to be the biggest benefit of zero-based budgeting compared to incremental budgeting and was the main reason why it was developed in the first place.

2. By its nature, it encourages a bottom-up approach to budgeting in order for ZBB to be used in practice. This should encourage motivation of employees.

3. It challenges the status quo and encourages a questioning attitude among Ministers/Commissioners/managers.

4. It responds to changes in the business environment from one year to the next.

5. Overall, it should result in a more efficient allocation of resources.

Drawbacks of ZBB

1. Departmental managers may not have the necessary skills to construct decision packages. They will need training for this and training takes time and money.

2. In a large organization, the number of activities will be so large that the amount of paperwork generated from ZBB will be unmanageable.

3. Ranking the packages can be difficult, since many activities cannot be compared on the basis of purely quantitative measures. Qualitative factors need to be incorporated but this is difficult. Top level management in the Ministries/organizations may not have the time or knowledge to rank what could be thousands of packages. This problem can be somewhat alleviated by having a hierarchical ranking process, whereby each level of managers rank the packages of the managers who report to them.

4. The process of identifying decision packages and determining their purpose, costs and benefits is massively time consuming and costly. One solution to this problem is to use incremental budgeting every year and then use ZBB every three to five years, or when major change occurs. This means that an organization can benefit from some of the advantages of ZBB without an annual time and cost implication. Another option is to use ZBB for some departments but not for others. Certain costs are essential rather than discretionary and it could be argued that it is pointless to carry out ZBB in relation to these. For example, heating and lighting costs in a school or hospital are expenses that will have to be paid, irrespective of the budget amount allocated to them. Incremental budgeting would seem to be more suitable for costs like these, as with building repair costs.

5. Since decisions are made at budget time, managers may feel unable to react to changes that occur during the year. This could have a detrimental effect on the business if it fails to react to emerging opportunities and threats.

6. The organization’s management information systems might be unable to provide the necessary information.

Zero-based budgeting tries to achieve an optimal allocation of resources to the parts of the business where they are most needed. It does this by forcing managers/ Ministers/ Commissioners to justify every activity in their department/ Ministries as they know that, until they do this, the budget for their department/ Ministries are zero. If they are unable to do this, they aren’t allocated any resources and their work therefore stops as does their employment within the organization, at this point, presumably. In this way, all unjustifiable expenditure theoretically ceases.

It could be argued that ZBB is far more suitable for public sector than for private sector organizations. This is because, firstly, it is far easier to put activities into decision packages in organizations which undertake set definable activities. governments, for example, have set activities including the provision of housing, schools and local transport. Secondly, it is far more suited to costs that are discretionary in nature or for support activities. Such costs can be found mostly in not for profit organizations or the public sector, or in the service department of commercial operations.

Finally
Budget helps to aid the planning of actual operations by forcing managers to consider how the conditions might change and what steps should be taken now and by encouraging managers to consider problems before they arise. It also helps co-ordinate the activities of the organization by compelling managers to examine relationships between their own operation and those of other departments.

The budget of a government is a summary or plan of the intended revenues and expenditures of that government. There are three types of government budget : the operating or current budget, the capital or investment budget, and the cash or cash flow budget.

The cash budget is important because it helps the business owner manage the net working capital of the company. Business owners You normally prepare a cash budget every month, although some business owners choose to prepare the cash budget quarterly. You can think of the cash budget as a short-term financial instrument; it’s less formal than a comprehensive statement of cash flows and, therefore, easier and faster to prepare. It describes how much cash your firm is taking in and how much cash it is taking out. The cash budget document, therefore, tells you how much cash is available to the firm at the end of each month.

If the cash budget shows an increase in net working capital, you may use that increase to reduce operating costs — by repaying borrowed money, for example. If the cash budget shows a decrease in net working capital, you may need to find some way of increasing available cash — by drawing on a line of credit, taking out a bank loan or by factoring. Factoring, which is particularly common in the clothing industry, consists of selling your accounts receivable at a discount to a third-party. Because the factoring party takes over the ownership of the receivable from the business owner, therefore looking to your customers rather than to your company for payment, it’s a good way of raising capital when your credit status may not support a loan. 

The Statement of Cash Flows is a more comprehensive statement prepared along with the Income Statement and Balance Sheet. Generally speaking, the Statement of Cash Flows is a more formal presentation of the credit and debit items presented in the cash budget. It looks at many of the same sources and uses of cash presented in the Cash Budget document over a longer period of time, normally at the end of the fiscal quarter and again a year’s end. For a more comprehensive explanation of how statements of cash flows are prepared, read preparing a Statement of Cash Flows.

One of the differences between the Cash Budget and the Statement of Cash Flows is that for public companies, the Statement of Cash Flows is part of the required financial statement that must be prepared and presented according to the standards of the FASB (the independent Financial Accounting Standards Board). Although not legally required, most accounting firms preparing financial statements for private companies adhere to the same FASB standards.

Another big difference between the short term Cash Budget and the longer term Statement of Cash Flows is that the latter includes depreciation. Although the depreciation expense does not change a company’s net cash position, the real value of a company necessarily accounts for the decline in value of most business assets over time.

ZBB requires all costs to be justified, it would seem inappropriate to use it for the entire budgeting process in a commercial organization. Why take so much time and resources justifying costs that must be incurred in order to meet basic production needs? It makes no sense to use such a long-winded process for costs where no discretion can be exercised however. Incremental budgeting is, by comparison, quick and easy to do and easily understood. Therefore, the use of incremental budgeting indisputably gives rise to inefficiency, inertia and budgetary slack.

Beyond budgeting model as having particular relevance for knowledge-based companies which are increasingly features of a developed economy. Other companies may see specific benefits in such a system, given the rapidly changing environment in which they operate. These changes will not be introduced without conflict and difficulty due to the challenges faced in introducing change. Such challenges may be beyond the achievement of the public sector, due to the expression in the budget of politically-motivated policies and objectives developed within a complex legal and financial framework. What we can say, however, is that if we are to see the successful application of the beyond budgeting model in both private and public sectors, then this must be underpinned by a considerable organizational, cultural and managerial change. Otherwise it is doomed to failure.

In conclusion, neither budgeting method provides the perfect tool for planning coordination and control. However, each method offers something positive to recommend it and one cannot help but think that the optimal solution lies somewhere between the two.

In summary, the purpose of budgeting tools:
A. The tools provide a forecast of revenues and expenditures, that is, construct a model of how a business might perform financially if certain strategies, events and plans are carried out.
B. The tools enable the actual financial operation of the business to be measured against the forecast.

C. Lastly, tools establish the cost constraint for a project, program, or operation.

Dada Suraju Adefolami, Professor of Finance, School of Business Administration. UNEM University, Costa Rica, is a Finance / management Consultant and Certified Forensic Accountant. You can reach him via: [email protected]: 08052043855