Traditional Budgeting vs Zero Based Budgeting

Article bySayantan Mukhopadhyay
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Differences Between Traditional and Zero-Based Budgeting

Traditional budgeting and Zero based budgeting are the resource allocation methods, the difference between which lies in the methods adopted to achieve proper budgeting. Traditional budgeting is a very simple method, and it is computed based on historical data. It can be used for all the departments of an organization. In contrast, zero-based budgeting is a complicated method computed based on estimated data, which can only be used in the case of a profit center.

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The most crucial difference between traditional and zero-based budgetingZero-based BudgetingZero-based budgeting refers to the budgeting method whereby the expenses and income on the list start from zero. There is no reference point for the budget items, and each of these expenses is individually interpreted as per requirement.read more is that the costs aren’t minimal in traditional budgeting since we consider the previous year’s expenditure. However, in zero-based budgeting, the costs can be minimal as we consider the starting point zero.

Companies budget the costs/expenses to make sense of what may happen in the future. Setting a budget ensures that the businesses are allocating their capital right and are allowing the costs to be minimal.

One of the most common budgeting methods is traditional budgetingTraditional BudgetingTraditional budgeting is one of the ways for preparing a company's budget for a specific time period in which the previous year's budget is used as the base for preparing the current year's budget.read more. As per traditional budgeting, a company sets forth its forecast of expenses based on the previous year’s expenditure.

On the other hand, zero-based budgeting, which happens to be a popular budgeting method, assumes nothing; instead, they base their assumptions on budgeting as zero.

Traditional Budgeting vs Zero Based Budgeting – Comparative Table

Basis for ComparisonTraditional budgetingZero-based budgeting
1. MeaningWe calculate by keeping the previous year’s budget as a base;We calculate by keeping the starting point as zero;
2. PreparationQuite simply.Very complex.
3. EmphasisExpenditure for the previous year.We consider each item as per the new economic appraisal.
4. ApproachBased on historical information.Based on estimated information.
5. Cost-effective?It doesn’t encourage cost-effectiveness.The purpose is to ensure cost-effectiveness.
6. Prefers All departments.Only profit centersProfit CentersProfit Center is the segment or division of a business responsible for generating revenue & contributing towards its overall profit. Here, the objective is to increase sales & reducing the cost incurred. read more.
7. EffectivenessEffectiveness depends on the individuals who did the previous year’s budgeting.Effectiveness depends on the current top management of the company.
8. Linked toAssumptions of the previous year.Estimation of which department can bring more profits.
9. ClarityAlmost none.High.
10. OrientationOrientation revolves around accounting.Orientation sits around the project/decision unit.

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What Is Traditional Budgeting?

Traditional budgeting is one of the most common budgeting methods. In this budgeting method, a company sets forth its forecast of expenses based on the previous year’s expenditure. It involves maintaining multiple spreadsheets to load data as it makes estimates based on the historical data. Sometimes, maintaining whole lot of data consumes ample amount of time, which makes companies opt out of it.

However, this method being a simpler one is the first choice of companies, at least until it operates on a smaller scale and data maintenance remains in control. Once the number of spreadsheets to be maintained goes beyond handling limits, firms look for another budgeting method.

Traditional budgeting does not take into consideration the existing project. All it considers is the data of the former year. This method is based on the basic principles of cost accounting. The accounting professionals are concerned more about how capable was the firm in dealing with the expenses in the former years than accounting for the current capabilities of the company.

What Is Zero-Based Budgeting?

The zero-based budgeting refers to the method of budgeting which is based on facts and figures. It all starts from scratch when it comes to framing or preparing a budget for companies. Given it begins at zero, it is so named.

This budgeting method is preferred by companies that want to operate on no assumptions. This is a more reliable approach toward budgeting for them.  It ensures cost-effectiveness and detailed orientation, which help a business generate more profits and an individual save and invest more money.

The zero-based budgeting takes into consideration the existing projects and upcoming ones as well to ensure the budget allocation is per the costs and benefits. It is a more clear and practical approach to allocating resources. Hence, companies operating on a larger scale prefer using this method.

Traditional Budgeting vs Zero Based Budgeting Infographics

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Traditional vs Zero-Based Budgeting – Key Differences

Let us have a quick look at the major differences between both traditional and zero-based budgeting methods below:

  • Traditional budgeting needs a reference point; zero-based budgeting, on the other hand, always starts from zero.
  • Traditional budgeting takes the preceding year’s expenses as base data points; zero-based budgeting takes the strategic approach to assigning budgets to each unit/department.
  • Traditional budgeting is simplistic since it is done regularly with a similar approach; zero-based budgeting is quite complicated since it encourages re-evaluation during usage.
  • Traditional budgeting is based on historical information, which revolves around accounting. Zero-based budgeting is based on estimated data, and that’s why it revolves around decision-making.
  • Traditional budgeting encourages similar costing to the previous year. Zero-based budgeting supports cost-effectiveness.

Similarities

Companies budget the costs/expenses to make sense of what may happen in the future. Setting a budget ensures that the businesses are allocating their capital right and allowing the costs to be minimal. Both traditional and zero-based budgeting helps in achieving the purpose. While there are multiple differences between the two terms, there is also a set of similarities that must be focused on. Below is a list of some similarities between them. Let us have a quick look at them:

  • Both these methods emphasize the allocation of the budget with respect to the goals that organizations aspire to achieve.
  • Both these means of budgeting study a wide range of data and analyze them for a reliable allocation of resources.
  • The factors that influence these methods are almost the same. Some of these determinants include revenue projections, cost of goods sold (COGS), inflation, etc.
  • These ensure accountability from the respective departments of the organization. The methods do not simply suggest allocation but also hold accountability.
  • In both processes, the people at the top prepare a budget and distribute the plan to the individual sections of the organization.

Recommended Articles

This article has been a guide to what is Traditional vs Zero Based Budgeting. We explain the differences using a comparative table, infographics, and similarities. You may also have a look at the following articles –

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  1. Arnab Baidya says

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    • Dheeraj Vaidya says

      Thanks for your kind words!