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Why zero-based budgeting trumps incremental budgeting in COVID-19 era

There are some inherent advantages to zero-base budgeting as compared to the traditional mode of incremental budgeting in times of great disruption.

May 16, 2020 / 07:50 PM IST

Zero-based budgeting is a term that is likely to be used more frequently as we deal with the after-effects of COVID-19 on the corporate sector in the coming months. It contrasts sharply with the most widely prevalent form -- incremental budgeting.

Zero-based budgeting (ZBB) as the term signifies assumes that every line item reduces to zero when a fresh budget approval is sought. For approval, each line item has to be justified yet again. Due to the rigour involved in the ZBB process, accurate, efficient cost reduction is its key advantage.

Yet, the complexity of decision making in ZBB and the demands it makes on managerial bandwidth means that it is often slow and tedious. When improperly implemented, it may lead to corruption and bureaucracy. And some forward-looking expenses may easily get the short shrift in such a regime.

At the other end of the spectrum, the most commonly used budgeting method during the times of "business as usual" is the incremental budgeting tool. Here, the current year expenses are built on the back of the prior period expenses.

A quick and dirty method - this method assumes that almost all cost heads and departments will stay as they are in the following period as well. And as such the prior period numbers become the starting point for the future expenses.

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A vaccine works by mimicking a natural infection. A vaccine not only induces immune response to protect people from any future COVID-19 infection, but also helps quickly build herd immunity to put an end to the pandemic. Herd immunity occurs when a sufficient percentage of a population becomes immune to a disease, making the spread of disease from person to person unlikely. The good news is that SARS-CoV-2 virus has been fairly stable, which increases the viability of a vaccine.

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Easy to implement, incremental budgeting ruffles no feathers and does not stoke interdepartmental rivalry. There is almost immediate visibility on the cost structure of the forecasting period.

Given its 'status quoist' bent, incremental budgeting is not very efficient at cost reduction. It promotes overall budgetary slack as managers often get into a race to corner the most resources for their departments.

Given that most big economies of the world have been under lockdown for close to two months due to COVID-19, many companies across the world would clock zero revenue for at least a sixth of their annual budget cycle. The dislocations will also mean that the credit cycle would see an increase in the following months.

Under such circumstances where the business model per se would be under scrutiny, zero-based budgeting would make more sense. It will be a long and laborious process of at least six to nine months as they look within to scrimp and scrounge. And the companies that emerge on the other side of 2020 would certainly have better immunity to broader risk.
Moneycontrol News
first published: May 16, 2020 07:50 pm

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