Zero Based Budgeting is a method of budgeting where you literally start from zero every time you budget as you have to justify all your expenses every time you prepare a fresh budget. In other words, you start with a clean slate and have to analyze your needs and costs for each category and allocate resources accordingly disregarding your previous budgets.
As you can imagine it is a time-consuming process when compared to traditional budgeting which uses previous budgets in determining what to put in a new budget.
Traditional budgeting usually involves just applying for example a 4% increase over previous budget lines in making a fresh budget.
As an individual or family, you can use zero-based budgeting to help you reevaluate your priorities and goals every time. In time you may discover that certain expenses are not worth it. You can also find that there are cheaper alternatives for some expenses.
According to McKinsey, Zero-based budgeting has been shown to reduce sales, general, and administrative costs by 10 to 25 percent within as little as six months if properly implemented.
It can do the same if you apply it to your family budget too.
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Advantages of Zero-Based Budgeting
Below are the advantages of a zero based budgeting.
1. It Can Lower Your Costs
One of the biggest advantages of zero-based budgeting is that it can lower your costs. As already pointed out earlier using zero-based budgeting can reduce variable costs by as much as 25% over a six months period for companies.
Try it in your family budgeting process and I am very sure that it will help you save money.
2. It Forces You To Do a Cost-Benefit Analysis
One of the cornerstones of a zero-based budgeting process is that it forces you to justify your costs. As a result of this, you may realize that some costs are not really worth it.
For example, as a family, you may discover that your phone costs can be reduced by switching to other carriers.
You may also find out that some you don’t need certain services such as gym memberships as you rarely use them.
3. It improves Efficiency In Use of Resources
Another advantage is that Zero-Based Budgeting can improve efficiency in the use of your resources.
For example, while preparing your budget line for electricity you may discover that the electric bulbs you are using are not efficient.
As a result, you may opt for energy-efficient bulbs that will not only save you money but will last longer.
The fact that this type of budgeting focuses on cost and benefit means that efficient use of resources is bound to be the result of your efforts.
Disadvantages of Zero-Based Budgeting
Below are the disadvantages of zero-based budgeting.
1. It take Time To Prepare
One of the main reasons that people give for not using zero-based budgeting is the time it takes to prepare one.
This is because you will have to start from zero or from nothing and not use previous budget costs.
It also takes time to justify all your expenses especially if you are preparing one for a big organization.
2. Risk of Focusing on Short Term Needs and Goals Over Long Term Needs and Goals
Another disadvantage is that you may focus on the short term at the expense of long term needs and goals.
For example, a company if not careful can focus on areas that can improve profits now but fail to fund long term investments in research and development.
And yet it is these long term investments in research and development that can determine whether your company is viable or not.
The same can apply to families too as you may focus on short term expenses instead of focusing on long term expenses such as buying a house, education, etc.
3. It is Costly To Prepare
Because you are starting from a clean slate, preparing zero-based budgeting is very costly in terms of time and resources. Instead of employees being involved in operations they will be spending hours preparing zero-based budgeting.
This may not be apparent in a family setting but families too do need time to do other things like watching football, going to the park, etc. Therefore the time spent preparing this budget can impact such activities.
However, this cost has to be weighed against the benefits of preparing a zero-based budget which in my opinion outweigh the costs.