A budget is a plan of operations and activities for the next period, like a month, quarter or year, expressed in quantitative terms. Zero-based budgeting is a method of budgeting which requires you to specifically justify each cost element, as if the activities were being undertaken for the first time. Incremental budgeting is an approach to budget creation that assumes there will be little change in activity for next year compared with the current year.
In principle, zero-based budgeting requires you prepare the budget starting at zero budget levels every quarter or year. You don’t have to start from zero, but can instead start from the current level of expenditure and work downwards. While doing this, consider what would happen if any particular aspect of current expenditure and operations were removed from the budget. Incremental budgeting requires you to only add or subtract from the previous cost levels. You start with the previous period’s budget and add or subtract from it according to the expected needs.
In zero-based budgeting, you are required to justify every dollar of costs from a zero base, as if the programs involved were being initiated for the first time. In contrast, incremental budgeting requires you to justify only additions to or subtractions from the previous cost levels.
Incremental budgeting encourages slack and wasteful spending to creep into budgets. This is because by using this system, you will be perpetuating past inefficiencies, since cost levels are rarely subjected to close scrutiny. In zero-based budgeting, every aspect of the budget is examined in terms of its cost and its benefits, thus eliminating wasteful and inefficient operations.
In zero-based budgeting, each organizational activity, or decision package, is evaluated and ranked based on its benefit to the organization. Activities which are vital to the very existence of the organization, such as employees, are given the highest priority. Resources are then allocated in the budget, according to the funds available and the evaluation and ranking of the competing packages. In incremental budgeting, the previous year’s funds allocated to an activity are simply adjusted for inflation, regardless of the ranking of the activity.
Frequency of Preparation
Another way zero-based budgeting and incremental budgeting differ is in terms of the frequency of preparation. Owing to the huge amount of managerial time needed to draw them up, zero-based budgets are prepared every five or so years. Incremental budgeting is carried every year, since the previous year’s budget must be incorporated when preparing it.