Skip to content

Cost Accounting · Budget and Budgetary Control

Zero Base Budgeting and Performance Budgeting Explained

Updated 10 October 2026 · Fact-checked

Zero base budgeting (ZBB) builds every budget from scratch. Each activity must be justified, costed as a decision package and ranked by benefit, and funds go down the ranking until money runs out. Performance budgeting links spending to measurable outputs and targets. In exams, define, list steps, rank packages and state merits and limits.

Understand Zero Base Budgeting and Performance Budgeting

Most firms use incremental budgeting. They take last year's budget or actual figures and add or subtract a percentage for inflation and growth. It is quick and simple. Its weakness is that old inefficiencies and unneeded activities carry forward year after year, because the base is never questioned.

Zero base budgeting (ZBB) removes that base. Every activity is treated as new, with a starting budget of zero. Each manager must justify why the activity should exist, what it will cost and what it will deliver. Money is given only to activities that earn it. ZBB suits discretionary and support costs such as HR, IT, training, advertising and R&D, where output is hard to link to cost. It is less suited to costs that clearly vary with production.

The working unit of ZBB is the decision unit (a cost centre or activity) and the decision package. A package describes one activity: its purpose, cost, benefits, alternatives and consequences of not doing it. Packages are of two kinds. Mutually exclusive packages are alternative ways of doing the same job, and only one is chosen. Incremental packages are levels of effort for one activity. The first is the minimum level needed to keep the activity running. Later packages add higher levels of service, each with extra cost and extra benefit. Management then ranks all packages by benefit and cost-benefit and funds them in order until the budget limit is reached.

Performance budgeting presents the budget by function, programme and activity, and links each to physical targets and unit costs. It asks what is being achieved for the money, not just what is being spent. Typical features are clear objectives, measurable work units (such as cost per kilometre of road or per patient treated), responsibility for each programme and a comparison of actual performance with targets. It is widely used in government and public bodies.

Programme budgeting (planning-programming budgeting) groups activities by the programme or objective they serve, even if they cut across departments, and looks at costs and benefits over several years. Other modern ideas you should know are the rolling (continuous) budget, which is updated every month or quarter by adding a new period as one expires so the budget always covers a fixed horizon, and the activity-based budget, which budgets by cost drivers of activities.

Key rules to remember

Incremental budget
Budget for new period = Last period's budget (or actual) ± expected change
The base is accepted without questioning. This is the contrast case for ZBB.
ZBB funding rule
Fund packages in rank order until the available budget is used up
The minimum-level package of each activity comes before higher-level packages of the same activity.
Cost-benefit ranking
Benefit ÷ Cost (or ranking score) for each package
Use it only when the question gives benefits in numbers. Otherwise rank by management judgement and state the reason.
Unit cost in performance budgeting
Cost per unit of work = Programme cost ÷ Units of output
Compare with the target unit cost to judge performance.
Rolling budget
At each review: drop the expired period, add a new period, revise the rest
The horizon stays fixed, for example always 12 months ahead.

How to solve Zero Base Budgeting and Performance Budgeting questions

For a theory question, follow a fixed structure. For a numerical question, the work is mainly ranking and funding packages.

  1. 1Read the question verb. Is it asking you to explain, compare, list steps, or prepare a ranking?
  2. 2For theory, define the technique in one or two lines and state its basic idea.
  3. 3List the steps in order: define objectives, identify decision units, prepare decision packages, rank them, allocate resources, then prepare and monitor the budget.
  4. 4Add merits and limits in short bullets, each with a one-line reason.
  5. 5For a numerical, list every package with its cost and benefit or priority score.
  6. 6Rank packages. Keep each activity's minimum package before its higher levels.
  7. 7Fund packages in rank order within the budget limit. Show the running total.
  8. 8State which packages are left out and give a one-line comment on the effect.

Quickest way: Rank, fund and stop

When to use it: Use it for numerical questions with decision packages and a fixed budget limit.

  1. Write a three-column list: package, cost, rank or score.
  2. Sort by rank. If ranks are not given, sort by benefit per rupee.
  3. Check that each higher level of an activity comes after its lower level.
  4. Keep a running total of cost and stop where the next package would exceed the limit.
  5. Write the funded list and the total, then the rejected list.

Common mistakes in Zero Base Budgeting and Performance Budgeting

  • Saying ZBB means the budget is actually zero.

    The name is read literally.

    Fix: Write that only the starting base is zero. Every activity must be justified afresh, and many will still be funded.

  • Funding a higher-level package before the minimum package of the same activity.

    Students rank only by score and ignore dependence.

    Fix: Treat incremental packages as a chain. The minimum level must be funded first.

  • Mixing up mutually exclusive and incremental packages.

    Both are described as alternatives.

    Fix: Exclusive packages are different ways of doing one job, so pick one. Incremental packages are levels of effort, so they add up.

  • Treating performance budgeting as the same as ZBB.

    Both are modern and justify spending.

    Fix: Performance budgeting links spending to output targets and unit costs. ZBB re-justifies activities from zero. They can be used together.

  • Listing merits only, with no limits.

    Students assume the technique is simply better.

    Fix: Always give both. Limits include heavy paperwork, time, manager skill needed, short-term bias and difficulty ranking social or support activities.

  • Describing a rolling budget as a yearly budget revised once.

    It sounds like a revision.

    Fix: State that it is updated regularly, with a new period added as one ends, so the horizon stays constant.

Worked examples

Example 1

Sunrise Textiles Ltd has ₹6,00,000 for its HR department. Decision packages, in order of priority, are: P1 Payroll and compliance (minimum level) ₹2,50,000; P2 Recruitment, minimum level ₹1,50,000; P3 Training, minimum level ₹1,20,000; P4 Recruitment, higher level ₹1,00,000; P5 Training, higher level ₹80,000. Decide which packages are funded.

Show the solution
  1. Rank list is P1, P2, P3, P4, P5. Minimum levels come before their higher levels, which is satisfied here.
  2. Fund P1: ₹2,50,000. Balance = ₹6,00,000 − ₹2,50,000 = ₹3,50,000.
  3. Fund P2: ₹1,50,000. Running total = ₹4,00,000. Balance = ₹2,00,000.
  4. Fund P3: ₹1,20,000. Running total = ₹5,20,000. Balance = ₹80,000.
  5. P4 costs ₹1,00,000, which is more than the balance of ₹80,000. It cannot be funded.
  6. P5 costs ₹80,000, which equals the balance, and its minimum package P3 is funded. Fund P5. Running total = ₹6,00,000.

Answer: Fund P1, P2, P3 and P5, total ₹6,00,000. P4 (higher-level recruitment) is not funded. Management may review whether P5 should rank above P4 if the ranking is flexible.

Example 2

Distinguish between incremental budgeting and zero base budgeting under four heads.

Show the solution
  1. Starting point: incremental uses last year's budget or actuals as the base. ZBB starts from zero.
  2. Justification: incremental justifies only the increase. ZBB requires justification of every activity and its full cost.
  3. Efficiency: incremental carries forward past inefficiencies. ZBB challenges and removes unproductive activities.
  4. Effort and cost: incremental is simple, quick and cheap to prepare. ZBB needs decision packages and ranking, so it takes more time, paperwork and skill.

Answer: Incremental budgeting adjusts the past, justifies only changes, may preserve waste and is easy to prepare. ZBB starts from nil, justifies every activity through ranked decision packages, improves resource allocation and demands more time and effort.

Exam tips

  • For a 'steps in ZBB' question, write the sequence with one line per step and mention decision units and decision packages by name.
  • Always give both merits and limits, and tie each to a reason in a few words.
  • In a ranking numerical, show the running total after each package. Step marks come from the working.
  • When asked to differentiate, use a table-style layout of points in short lines, and cover at least four points.
  • For MCQs, remember that ZBB suits discretionary and support costs, and that a rolling budget keeps a constant horizon.

Practice questions from Budget and Budgetary Control

Zero Base Budgeting and Performance Budgeting in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Zero Base Budgeting and Performance Budgeting: frequently asked questions

What is zero base budgeting in simple words?

It is a method where every activity must be justified from scratch for each budget period. Nothing is funded just because it was funded last year. Funds go to the activities that deliver the most benefit.

What is a decision package?

It is a document describing one activity, its purpose, cost, benefits, alternatives and what happens if it is dropped. Packages are ranked and funded in order. Each activity usually has a minimum-level package and higher-level packages.

What is the difference between performance budgeting and zero base budgeting?

Performance budgeting links spending to measurable outputs, targets and unit costs by programme or function. ZBB asks you to justify each activity from zero. One focuses on results, the other on justification, and they can be combined.

What is a rolling budget?

It is a budget that is updated regularly, for example every quarter. As one period ends, a new period is added at the end and the remaining periods are revised. This keeps a fixed planning horizon.