Zero Based Budgeting
Published Monday, 6 March 2006 - 13:22
Tom Lewis, from CIPFA, explores the concept of Zero Based Budgeting and how it can be applied to increase efficiency in Government.
Ten years on from New Labour’s first Comprehensive Spending Review (CSR), the Government intends to launch a second CSR, reporting in 2007, to identify what further investments and reforms are needed to equip the UK for the global challenges of the decade ahead. The 2007 CSR will include a set of Zero-Based reviews of baseline expenditure in Government departments.
Zero Based Budgeting (ZBB) is not new – it first appeared in the 1960s – and is an attempt to find a budgeting model that actually serves the objectives of the organisation. ZBB starts from the premise that no costs or activities should be included in a budget, just because they figured in the costs or activities in previous periods.
ZBB works as if the organisation is starting out afresh in the new planning period – it is as if the life of the organisation exists as a series of fixed term contracts. It is usually used most effectively where the activities involved are wholly or mainly discretionary in nature. But it is very easy to fall into the trap of assuming that something is non-discretionary, for no other reason than the activity has been carrying on at a similar level for a number of years.
This initially appears to be a very resource hungry approach, and if applied in this simplistic form, would quickly fall foul of the law of diminishing returns. However, the application of practical common sense to the ZBB concept quickly identifies potential gains.
ZBB can be applied usefully to budget heads such as repairs, maintenance or equipment costs. The traditional incremental approach often simply takes “last year plus x%”. But if proposals are presented with different options for service levels and predicted outcomes, funds can then be allocated on the basis of best value for money. ZBB is there to question set assumptions, and to provide a tool for systematically reprioritising, and perhaps withdrawing from long term activities that no longer align properly with objectives.
ZBB has its own jargon, the key term being the “Decision Package.” This analyses each discrete activity, according to cost and purpose, together with benefits, alternative courses of action, how to measure performance, and the consequences of not performing the activity. Decision packages should relate to activities that are stand-alone; a good test is whether a decision could be made to sub-contract, or to abandon the activity altogether. If such a decision could not be made, the activity is likely to be part of a larger decision package.
The decision packages are ranked in order of importance, using performance measurement tools such as cost/benefit analysis, but also allowing a level of subjectivity. Few activities are capable of reduction to a definitive measures, while some ideal measures may not be practical because of difficulties in real world application, or simply because of the costs of data collection. For example, managers may believe that there would be a “feelgood” factor in taking a particular course of action.
The ranking list results in a priority order for the allocation of resources. The final budget will be made up of the decision packages that have been approved for funding, whether they are existing ones, or new, reallocated into the appropriate operational units.
ZBB, when applied intelligently, parallels much of the thinking that underlies the Efficiency Agenda. Top management can expect to have available the detailed information that will enable decision-making, and that will highlight redundant activities or duplications of effort within an organisation.
The key benefit, though, is that ZBB serves to focus attention on the actual resources that are required in order to produce an output or outcome, rather than the percentage increase or decrease compared to the previous year. It should be more user friendly to operational managers than the traditional incremental budget model. It moves the process away from the bookkeeper’s number crunching spreadsheets, and engenders a balanced partnership between the finance professionals and the budget holders.
· A full briefing on zero based budgeting can be freely downloaded from the CIPFA website: www.cipfa.org.uk/pt/briefings.cfm
