Some govt departments will adopt zero-based budgeting this year. Here's what that means
- National Treasury and the department of public enterprises must adopt zero-based budgeting this year.
- This is the first time SA government departments will start from scratch when putting together a budget.
- For more stories go to www.BusinessInsider.co.za.
A radical way of budgeting is being adopted in the South African government for the first time this year.
When finance minister Tito Mboweni first mooted the idea of zero-based budgeting last year, some analysts thought it was just to send a signal that belts must be tightened.
But he was clearly serious; his own department, the National Treasury, as well as the department of public enterprises has to adopt this methodology this year.
What is zero-based budgeting?
Usually budgets work like this: the previous year’s budget is used as a starting point, and allocations to each department is increased or (very rarely) cut.
But with zero-based budgeting, every year you start from scratch.
Every line item is interrogated to see whether it is worth it, whether it will contribute to a company’s goals for the next year, and whether there may be a cheaper alternative.
If a department can’t properly justify a previous cost, it is left out of the budget completely.
What are the benefits of zero-based budgeting?
Instead of automatically including previous line items in a budget, careful consideration is now given to each cost – which should eliminate unnecessary expenses.
The approach also prevents the inclusion of items that aren’t core to a business, or do not align with its current needs. Often, budgets include expenses that were necessary a long time ago, but may not be required any longer; a zero base should get rid of those.
And even if a cost is included, those responsible for it are forced to look for the cheapest alternatives.
And the drawbacks?
It is extremely time consuming and takes real expertise for large organisations to draw up a budget from scratch every year.
There is also a big risk that expenses on unexciting, but core, functions that keep a company afloat and its customers happy, are hit – which could affect customer experience. For units that deliver intangible outputs (like HR, for example) it may be difficult to justify expenses that do not immediately result in increased profit.
Zero-based budgeting can also spiral out of control, and end up cutting too much out of a business.
Some analysts believe this is what happened with the takeover of the food giant Kraft Heinz by the Brazilian private equity firm 3G Capital, one of the biggest proponents of zero-based budgeting. Critics say cost-cutting due to this approach came at the expense of investments in growth and new ideas, which resulted in big losses at Kraft Heinz.
Who uses zero-based budgeting?
Peter Pyrrh, an accountant at the technology giant Texas Instruments, is credited with inventing the approach in the 1970s.
Currently, there are more than 300 large global companies that have adopted it. The Wall Street Journal reports that Covid-19 has convinced more companies to turn to zero-based budgeting. This is because the crisis has upended the way businesses work, and traditional line items like travel and entertainment may require more scrutiny in a locked-down world.
In the US, former President Jimmy Carter used it in his home state of Georgia, and wanted to roll it out for the national budget in the 1970s. But according to Deloitte, the approach proved too complicated and time consuming for the US government, and also ineffectual.
Why does Mboweni want to adopt zero-based budgeting?
Mboweni sees zero-based budgets as a way to allocate “funds according to our revenue base, avoid as much as possible borrowing to fund the gap and live within our means”.
Starting from scratch and working through expenditure by line item – while also looking at whether past expenses paid off - should certainly cut out some fat and may offer a better chance to balance government’s books.
Treasury says that the Department of Public Enterprises and the National Treasury should produce "significantly re-costed budgets from 2022/23".
Will it work in South Africa?
For zero-based budgeting to work, every department will have to justify all of their expenses – from scratch, every year, says Nazmeera Moola, head of SA investments at Ninety One and a member of the presidency’s State-Owned Enterprise Council.
This is a massive exercise, and the South African government doesn’t have the resources and skills to do this, she told Business Day TV last year.
Treasury, in this week's Budget Review, said that they have been reviewing government spending to improve efficiency in recent months.
"More than 30 spending reviews across all functions have been conducted to understand service-delivery outcomes and how these might change under different scenarios. These reviews will be used to inform the development of zero-based budgeting."
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