 Baseline Versus Zero-based Budgeting
Is your organization re-inventing the wheel each year
when it begins its budget process? Organizations that implement zero-based budget methods
may be doing just that. Instead of supporting managers with historical information, some
organizations insist that the budget process begin anew each year.
One of the primary benefits of zero-based budgeting is
that it forces preparers to think through their operations in order to plan for the
upcoming year. Advocates believe that in the process, preparers become much more aware of
the factors that have (and will have) an impact on their operations. The review process
offers preparers the opportunity to examine each of the factors and, possibly, to discuss
them with management.
Zero-based budgeting builds the preparer's knowledge of
the company and its operations whether the preparer is a longtime veteran or a relative
newcomer to the organization. In many cases, it can serve as a management tool to develop
lower-level managers' skills and their motivation.
Proponents insist that preparers who start from
'scratch' in developing their budgets will be more likely to base their budgets on
assumptions that are current and relevant. Many budget items do change from year to year.
By re-considering each item in the budget, the preparer may be more likely to account for
the effects of extraordinary or non-recurring items than if the calculations were based
upon only a cursory review of historical data.
Despite its advantages, there are major disadvantages
to zero-based methods. The most obvious is the amount of time and complexity involved in
the process. Without the benefit of historical or budgeted data to base their assumptions
upon, preparers may be forced to justify routine operations. That is to say that preparers
may spend inordinate amounts of time essentially recreating the effects of cyclical trends
in the business's operations.
Some businesses have very predictable operations that
vary little over time. It is neither efficient or effective for a preparer to spend a
great deal of effort developing data that could be obtained quickly and accurately by
extrapolating historical data. Baseline budgeting offers the preparer the advantage of
building upon the company's existing base of knowledge regarding its operations. Preparers
are often able to analyze historical data and extrapolate cyclical or seasonal trends
quickly. For many companies, this method is reliable and saves valuable time.
Baseline budgeting may actually improve the quality of
the organization's budgeted information. Instead of recreating existing information,
preparers can focus upon areas of the operations that may be exceptionally difficult to
budget or represent opportunities to plan at an even greater level of detail. Analysis of
historical data may remind preparers to factor into their budgets events or trends that
they may have otherwise forgotten or overlooked. The availability of historical data also
gives the preparer an opportunity to perform research quickly.
One of the most serious disadvantages to baseline
budgeting is that managers will sometimes rely upon historical data without considering
its relevance. If the preparer does not make the effort to determine whether the
historical data includes extraordinary or irrelevant items, then the process becomes less
valid (or invalid). Extrapolating historical trends without verifying the assumptions that
underlie the data, risks compromising the integrity of the budgeted data. Management
should establish controls, such as requiring assumptions, in order to ensure the
information's relevancy. An iterative review process can also help management to monitor
information quality.
Managers who are considering implementing or revising a
budget process should consider several factors before selecting either a baseline or
zero-based approach:
- availability and relevance of historical information
- organization's cyclical or seasonal trends
- likelihood of extraordinary or non-recurring budget
items
- preparers' experience in developing budgets
- amount of research and analysis necessary to develop
quality information
In addition to the aforementioned factors, managers
should also consider how information will be distributed, collected, and compiled.
Preparers will need plenty of support for their analytical and research efforts, as well
as tools that are well-suited to the task of developing a budget.
|
