Zero base budgeting represents a process where a business or government agency will create a budget with specific limits on an annual basis. This is different from incremental budgeting, in which a previous years' budget is used and a percentage increase is added to cap limits. Zero base budgeting starts every category at zero and will provide a spending limit based on necessary expenditures of the business or government agency. Advantages include increased restraint, reduced entitlements, and open budget discussions. Disadvantages may be increased time to plan budgets or an improper solution to spending problems.
Placing restraints on the budget process can help to ensure that no waste enters the budget. Often called budgetary slack, waste increases the budget spending limit for certain categories. Managers can "improve" their budget performance by not reaching this spending limit. This occurs because the manager does not intend to spend the amount of money listed in the budget, creating a false sense of performance. Zero base budgeting increases restraints on this behavior because managers will need to provide documented spending for each area.
Reducing entitlements is another benefit of zero base budgeting. Many government agencies have annual increases to entitlement programs that require corresponding budget increases. This can result in overspending with few analyses conducted to determine if the entitlement program is working effectively. Starting from zero each year for the budget process forces an analysis of the program to determine how much money the program needs to stay afloat. Only justified increases will be considered when setting current budget limits each year.
The two previous advantages leads to the third zero base budgeting advantage: open discussion. When individuals in a company or government must actively discuss restraints or annual spending limits, discussions and debates usually ensue. This allows everyone a say in the budget process, including lower-level employees. More open discussion can also lead to improvements to the budget and reduced spending from implementing new ideas.
Specific disadvantages to the zero base budgeting process include large amounts of time spent budgeting and lengthy solutions to simple problems. Allowing open discussion for the budget process can also result in everyone having a difference of opinion. This can lead to arguments and debates that detract from actually creating a budget. Squabbling about pet projects is one example of open discussion problems in the budget process.
Creating a major budget process for simple problems can also be a problem. Not all business issues will require a budget, and simple decisions blown out of proportion can lead to inclusion in the budget discussion. This will lengthen and detract the focus of finding a simple spending solution for a problem.