Budgets are important tools used by corporates and governments to assist planning for the future. Budgeting provides a basis to compare results with, evaluate performance and to take corrective actions for the future. The key difference between zero based budgeting and performance budgeting is that while zero-based budgeting is carried out by justifying all revenues and costs for the accounting period, performance budgeting takes into account the inputs and output per unit with the intention of efficient resource allocation.
CONTENTS
1. Overview and Key Difference
2. What is Zero Based Budgeting
3. What is Performance Budgeting
4. Side by Side Comparison – Zero Based Budgeting vs Performance Budgeting
5. Summary
What is Zero-based Budgeting?
When budgets are prepared by estimating and justifying all revenues and costs for each new accounting year, this approach is named zero-based Budgeting. Under this method, the budget preparation starts from scratch where every function within an organization is investigated for its expected revenues and costs. These budgets may be higher or lower than the budget of the previous year. Zero-based budgeting is more suited for high growth companies that use emergent strategies for growth since their potential revenues and costs changes frequently.
Zero- based budgeting has also gained much popularity during recent times due to the swift changes in business environment and markets. Incremental budgeting assumes that future will be a continuation of the past; however, it is questionable if this is fairly accurate. The forecasts and results of the prevailing year can change drastically during the upcoming year. Therefore zero-based budgeting is preferred by many managers to draft effective budgets.
This approach requires managers to provide explanations and justify all the revenues and costs for the upcoming year; thus, this is a very economic focused method. Waste can be eliminated by identifying and discontinuing non-value adding activities. Since a new budget will be prepared each year it is very responsive to the changes in the business environment.
Despite the advantages of zero-based budgets, they are difficult to prepare and extremely time-consuming where senior managers of all departments should provide explanations to justify all the expected results. Zero-based budgets are also criticized for been overly focused on short-termism, tempting managers to cut costs that may negatively affect the future.
What is Performance Budgeting?
Performance budgeting reflects the input of resources and the output of services for each unit of an organization. This type of budget is commonly used by the government to show the link between the funds provided to the public and the outcome of these services. Performance budgeting shows how funds are expected to turn into results, thus is often linked to broader efforts to control costs and increase performance and value creation in the public sector.
Many organizations have experienced a number of benefits from using performance budgeting, not least the fact that it generates a sharper focus on results within the government. The process also provides increased understanding of government goals and priorities and how different programs contribute to them. Governments have a number of programs and projects that they want to invest in; however, the available resources are scarce. Thus, performance budgeting can be efficiently used for planning and allocating resources. However, this approach often excessively focus on goal orientation, thus criticized to be significantly quantitative in nature and ignore qualitative factors.
Types of Performance Budgeting
Presentational Performance Budgeting
Performance information is presented in budget reports.
Presentational Performance Budgeting
Resource allocation is done based on the results obtained.
Performance-informed Budgeting
Resources are indirectly related to expected future performance.
Figure 1: Performance Budgets are widely used by governments to allocate funds and other resources
What is the difference between Zero Based Budgeting and Performance Budgeting?
Zero Based Budgeting vs Performance Budgeting |
|
| Zero-based budgeting is carried out by justifying all revenues and costs for the accounting period. | Performance budgeting takes into account the inputs and output per unit with the intention of efficient resource allocation. |
| Usage | |
| Zero Based budgeting is a popular budgeting system used by corporates. | Performance budgeting is primarily used by governments and public sector organizations. |
| Focus | |
| Zero based budgeting attempts to achieve cost reduction and better efficiency by planning costs and revenue for each accounting period. | Performance budgeting is focused on effective resource allocation |
Summary – Zero Based Budgeting vs Performance Budgeting
Zero based budgeting and performance budgeting are two types of budgeting mainly used by private sector and public sector organizations respectively. The main difference zero based budgeting and performance budgeting relates to zero based budgeting being flexible to react to market changes with carefully planning each expected result, and performance budgeting being widely used in contexts where the effective allocation of scarce resources is essential.
Reference:
1. “Zero-Based Budgeting – ZBB.” Investopedia. N.p., 10 Apr. 2015. Web. 15 Mar. 2017.
2.”Zero Based Budgeting- Meaning, Advantages & Disadvantages.” EFinanceManagement. N.p., 31 Dec. 2016. Web. 15 Mar. 2017.
3. Performance Budgeting: A Users’ Guide. Tech. N.p.: ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT, 2008. Print.
4. Gaille, Brandon. “10 Performance Budgeting Pros and Cons.” BrandonGaille.com. N.p., 13 Jan. 2017. Web. 15 Mar. 2017.
Image Courtesy:
1. “U.S. Defense Spending – percent to Outlays” By Farcaster at English Wikipedia (CC BY-SA 3.0) via Commons Wikimedia