Summary: Zero-Based Budgeting (ZBB) means budgeting your business around the assumption that all expenses need to be fully justified — even if they were normal in prior years.

Last year, marketing got over 30% of your company’s budget. Same thing this year? Research and development say they are close to a major breakthrough. Should you give them a bigger piece of the pie? Setting a budget is never easy, though perhaps the easiest way to do it is to adopt the status quo and essentially keep things the same.

However, is this the best way to cut costs and use your funds most effectively? Perhaps not. If you’re looking for alternative ways to manage your budget, zero-based budgeting is one idea you might want to explore.

What is Zero-Based Budgeting?

Zero-based budgeting, or ZBB is a technique for setting a new budget for each period by analyzing and justifying all expenses. Rather than basing allocations on past spending, ZBB requires each department or unit in an organization to present a case for its needs and costs for each new budget.

Past spending and whether each department will receive more or less than in the previous budget are not factors considered in ZBB. Instead, every time the budget is created, departments start from zero and receive budget allocations based on what they can prove they need.

Zero-based budgeting was created at Texas Instruments in Texas in the 1970s. It has since been used both by private businesses and government agencies. The goal of ZBB is to reduce wasteful spending and while it can be effective for identifying inefficiencies, it typically requires a lot more effort from department heads, managers, and accountants.

Traditional Budgeting

In order to illustrate the ZBB concept clearly, it’s worth taking a look at traditional budgeting as something to contrast it with. In traditional budgeting, departments or other units in an organization are generally allocated funding based on their perceived needs. These needs are then assumed to be constant unless the department or function spends much less or much more than its budget for the previous period.

If a department underspends, it may find that it is allocated less the next year. If it overspends, it may be granted more money to use the next year. Also, if new activities are added to a department’s responsibilities, it is usually granted an expanded budget, again based on the spending that these activities are perceived to require.

For example, it’s commonly accepted that marketing should make up around 5% of any company’s budget (perhaps less for business-to-business companies and more for business-to-consumer companies).

A newly created business might then automatically allocate 5% of its budget to marketing for its first year. If the marketing department spends all of its budget in that year, it would likely receive the same budget for the next year.

Problems with Traditional Budgeting

However, it can be argued that this system is inherently inefficient. 

First of all, granting the same budget to a department year after year suggests no change and no attempts to streamline. This may be a simplification, though, since departments may streamline and cut costs in some areas but also expand their activities in others and therefore end up with the same spending. 

Second, underspending in one period doesn’t automatically mean that the department won’t need more resources in the next period. For example, a sales department may underspend its budget in the first year of a company’s operations because it had to wait for newly developed products to come online. Its budget may be automatically cut for the next year, even though it will actually have more products to sell and need more staff and funding.

Finally, many companies look at actual spending to set their budgets. However, if a department overspends its budget and is therefore granted a higher budget the next year, this could be interpreted as rewarding inefficiency. Rather than requiring the department to streamline spending and cut costs, it is simply granted the same amount that it spent without necessarily justifying its costs.

All of these issues influenced the creation of zero-based budgeting to increase efficiency and cut down on waste.

How Does Zero-Based Budgeting Work?

With ZBB, all departments or functions of an organization start off the budget period, whether that’s a year, half a year, a quarter, or even a month, with no budget allocated to them. This is the zero-base in the name of this budgeting method.

Instead of an automatic allocation or one based on over- or under-spending the previous period’s budget, each department has to estimate and justify its budget for the new period. They typically do this by:

  1. Indicating key activities: Each department has to define its key activities and responsibilities. These can change over time, so they need to consider any new activities and estimate their costs. Past activities need to be analyzed to see if any have ceased or should be stopped if no longer practical or needed. A focus on labor cost is common. 
  2. Calculating financials: The department should indicate its expenditures and budget for the past period or possibly longer. If activities are going to cease, the spending on them should be subtracted. New activities will require newly estimated additions. 
  3. Applying performance measures: Departments should select key performance indicators (KPIs) for their programs/activities. These programs should then be assessed for performance, and this is related to their budgets. 
  • Programs that have sufficient budgets and inadequate performance may be eliminated or restructured. 
  • Programs with poor performance but insufficient budgets may need to receive increased funding.
  • Spending on programs that have sufficient budgets and good performance can be justified. 

In some organizations, departments are required to assess their programs/activities based on alternative budgets. For example, they may have to calculate their spending based on lower budgets than their previous year’s budget.

They can be asked how they would manage their spending if they received only 80% or even just 50% of the previous year’s budget. In indicating what they’d have to keep and cut, these assessments provide the organization’s management with concrete options for reallocating their budgets.

Advantages of Zero-Based Budgeting

The zero-based budgeting method is considered to be a viable alternative to traditional budgeting and has been used by private organizations and governments because of the following advantages:

  • Can help to streamline costs and eliminate wasteful spending
  • Helps to increase revenues by focusing on high-income generating activities while potentially eliminating those that produce little income
  • Creates more organization-wide collaboration and focus on budgeting
  • Ensures budget allocations are in line with organizational strategy and objectives

Disadvantages of Zero-Based Budgeting

While the advantages of ZBB are clear, they are countered by disadvantages that make this method challenging, including:

  • Time-consuming and resource-intensive
  • May have a more short-term focus by emphasizing high revenue-generating activities in the present
  • Implementation can be challenging, as most people aren’t familiar with the method
  • Can risk cutting programs/activities that haven’t yet been justified but which can produce important results in the future (ex. research and development)
  • Can cause constant disruptive change within organizations (staff turnover, implementing and canceling programs, etc.)

Zero-Based Budgeting Method

In zero-based budgeting, everything starts anew for each budget period. Rather than departments having set budgets they can depend on year after year with only slight changes, the ZBB method gives away nothing without justification. This means that departments have to prove the value and worth of their activities or risk having them defunded.

While ZBB can be effective for reducing wasteful spending, it can also be disruptive and very time-consuming, which means this budgeting method is an alternative that may only work well for some businesses.

FAQ

Yes, this method was created within a large company, Texas Instruments. In the 1970s and 80s, it was used by the US federal government. Some states continue to use a modified ZBB method to set their budgets today. In recent years, ZBB was implemented within X (ex-Twitter) and may have also implemented US federal policies and spending in 2025.

In terms of zero-based budgeting, a zero base is the starting point for every department or function. Nothing starts with funding, so every department has a base of zero and only receives budget allocations to build on that base by justifying its spending for the past and the future.