Zero-based Budgeting
Zero-based budgeting (ZBB), as the name suggests, is the budgeting technique that requires the preparation and explanation of each budget from zero. It is a method in which all the activities are reassessed, every time the budget is created. It is created without making any reference to the base past budgets and actual happenings.
In simple terms, it is the budgeting technique in which the cost component needs specific justification as if the activities relating to the budget were carried on for the first time. Thus the burden of proof is on the manager to explain the reason for spending money on a particular activity and what the consequences are if the proposed activity is not undertaken. In the absence of approval, the budget allowance is zero.
A 5-step Process to Implement Zero-based Budgeting
- Ensure financial transparency: There must be granular visibility into whether costs are variable, fixed, discretionary or nondiscretionary, and the impact on costs if spending changes.
- Identify strategic priorities and KPIs: Cascade strategic priorities against which to evaluate and align costs. Identify KPIs to measure the success of investment.
- Align, evaluate, and optimise: Conduct the process of zero-based budgeting as a right sizing exercise. Plan to repeat it every two to three years.
- Control and monitor the budget: Perform monthly or quarterly reviews to identify budget variances aligned with business priorities and actions to address variances.
- Embrace value-based spending: Operationalise the concepts of ZBB through an ongoing process of active assessment of all spending, regardless of whether or not it has been previously agreed to in the budgeting process.
Zero-based Budgeting Advantages
There are several benefits to zero-based budgeting, which make it an appealing option for companies looking to understand how their funds and resources are allocated at a granular level.
1. Enhanced Agility
One advantage of zero-based budgeting (ZBB) is that it boosts the flexibility of your finance team. Budget administrators must begin from scratch and defend their resource needs during each budgeting cycle, which is invaluable during periods of economic uncertainty.
2. Optimised Data
Companies that take a zero-based approach to their budget treat data as a valuable corporate asset, avoiding the confusion caused by disjointed spreadsheets and poor data governance. Each value assigned to the budget must have an accompanying need, ensuring that no extraneous expenses are added.
3. Quicker Forecasting
Zero-based budgeting requires validated and orderly data, which is another advantage. This same data set can expedite your forecasting processes, significantly reducing the time required to forecast your earnings and revenue.
Zero-based Budgeting Disadvantages
Disadvantages of zero-based budgeting, and how you can overcome them.
1. Limited Visibility
While ZBB excels in many areas, it falls short in projecting long-term outcomes when compared to conventional methods. This is because ZBB's focus is on readjusting the budget, rather than forecasting the future. To address this, it’s important to allocate time to not only reviewing your budget but also prioritising long-term strategic initiatives.
2. Labour-intensive
For organisations accustomed to an incremental approach to budgeting, ZBB can seem demanding. Each department must substantiate its expenses and plans without leaning on assumptions from previous years. Despite being a great way to curb overspending, ZBB necessitates collaboration across various departments within the organisation.
3. Measurement Difficulty
When a department's productivity isn't easily quantifiable, deciding where to allocate funds and justifying these expenses to senior management can pose a challenge.
Business Benefits of ZBB
Zero-based budgeting can drive significant savings and efficiency, but it is much more than simply building a budget from zero. ZBB is all about building and promoting a culture of cost management and accountability. With profitability and cost management, narrative reporting, and scenario modeling, ZBB allows your company to consider the highest priorities as opposed to what has been done historically. With the cost savings that are discovered, business leaders can then focus on making the changes necessary to keep up with customer needs, emerging competitors, and economic shifts.
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