Zero Based Budgeting

A well-planned budget can help you get the most out of your money, regardless of whether you are starting a new career or running an established enterprise. Since cash-strapped businesses must justify every pound they spend, zero-based budgeting seems to be an excellent solution for startup owners in recent years.

The adoption of zero-based budgeting has been increasing across industries. According to a survey by Deloitte in 2019, over 70% of companies surveyed had either implemented or were in the process of implementing zero-based budgeting.

Small businesses must reduce unnecessary expenses during growth to cope with the volatile UK economy. In today’s blog post, we will learn what zero-based budgeting is, how it differs from traditional budgeting, and discuss its advantages and challenges.

Table of Content

What is zero-based budgeting?
How does zero-based budgeting work?
Zero-based budgeting vs traditional budgeting
What are the advantages and challenges of zero-based budgeting?
Zero-based budgeting best practices
Conclusion

What is zero-based budgeting?

Zero-based budgeting (ZBB) is a popular budgeting approach in which your expenses must be determined for a new period or year starting from zero. It is different from traditional budgeting, where you depend on previous year’s budget and expense levels to adjust to the present needs. As you start from a zero base since the beginning of each budget, you can create an effective process for assessing and deciding on how to allocate your funds.

Every single expense must be justified, like starting from scratch.

ZBB was developed by Pete Pyhrr in the 1970s, who was a former accounting manager with Texas Instruments. The primary goal of zero-based budgeting was to assist organisations in reducing their costs and encouraging fiscal responsibility.

ZBB is an effective business planning tool that can assist in regulating company spending, determining, and eliminating unnecessary expenses, and concentrating on high-profit projects.

It is more than just deploying a one-time cost reduction strategy but using facts to determine how to liberate resources and allocate them smartly. ZBB delivers maximum value to organisations depending on the circumstances, goals, and people throughout the business.

How does zero-based budgeting work?

It operates similarly to any other budgeting technique which it examines income and assign specific amounts to certain categories such as marketing spend, PPC campaigns, or debt repayment.

When using zero-based budgeting, the annual budget is created from “zero bases,” or nothing at all. This method ignores previous spending and analyses the needs and costs of every department inside an organisation.

It is applicable to any type of cost, including capital expenditures, research and development expenses, operating expenses, and cost of goods sold.

Companies that successfully implement ZBB often report significant cost savings. According to a study by McKinsey & Company, companies that adopt zero-based budgeting can achieve cost reductions of 15% to 25% or more over a few years.

Zero-based budgeting vs traditional budgeting

Here are few difference between traditional and zero-based budgeting.

Basis of comparison	Traditional budgeting	Zero-based budgeting
Meaning	It is budget prepared using the previous year’s budget as a base	Zero is used as a basis for budget preparation
Focuses on	Previous expense levels	New expenditure justifications
Orientation	Cost accounting oriented	Decision-oriented or project-oriented
Justification	No justification for your current projects is needed	Justification of your ongoing and proposed projects is a must, along with considering your costs and benefits
Justification Authority	The top management is responsible for providing justification for particular decision unit	The manager provides the justification for a particular decision unit
Priority	Prioritises past spending levels, demand for inflation and new programs	The decision unit is first divided into multiple comprehensive decision packages and then ranked according to their relevance
Clarity and responsiveness	Lower clarity and responsiveness in comparison to zero-based budgeting	Higher clarity and responsiveness
Budgeting Approach	Routine approach	Straightforward approach

What are the advantages and challenges of zero-based budgeting?

There are many reasons why zero-based budgeting might be the best budgeting technique. However, this budgeting approach does have certain challenges that you must be careful about. We will share with you both the advantages and challenges of ZBB here.

Advantages of ZBB

ZBB is superior to traditional budgeting in many ways. Although ZBB has an awful reputation for being an entirely cost-cutting exercise, it can assist you in aligning spending with your additional revenue generation. Here are a few other advantages of ZBB.

Helps in determining whether all the departments of your company are adequately funded
Enables managers to concentrate on current financial metrics rather than those in previous budgets
Eliminate unnecessary spending by identifying and resolving expense issues
Improve departmental communication by including your employees in budget prioritising and decision-making processes.
Set clear and achievable savings goals
Create a customised financial plan to suit your lifestyle

The main goal of ZBB is to create and advance an accountable and cost-management culture. With the help of ZBB’s profitability and cost management, narrative reporting, and scenario modelling, your business can think beyond what has been done in the past and focus on its top priorities.

Once cost savings are realised, company executives may concentrate on implementing the changes required to meet client demands, new competitors, and fluctuations in the economy.

Challenges of ZBB

ZBB can be a useful budgeting technique; however, putting it into practice might be difficult at times. The process takes a lot longer than traditional budgeting because budgets are made from scratch. ZBB may have the unintended consequence of prioritising immediate cost savings over long-term advantages.

Some essential expenses, including long-term strategic projects or research & development, may be neglected in an attempt to cut costs.

Moreover, ZBB cannot promise you to save money unless you are executing zero-based budgeting strategies carefully. Similarly, it can be hard to create and follow a budget if you have variable income, which is unpredictable or unknown to you. These expenses change every month, which means you create a monthly budget by considering your income and expenditures.

This procedure can be complex, especially when managers don’t want to justify their spending out of fear of losing budgets. Therefore, clear communication at all levels of your business is essential as it can make the budgeting process more effective.

Zero-based budgeting best practices

Implementing zero-based budgeting (ZBB) effectively requires attention to certain best practices to ensure its success. Here are five key best practices for zero-based budgeting:

S. No.	Best Practice	Best Practice	Rationale
1.	Thorough activity analysis	Conduct a comprehensive analysis of all activities and programs within the organization	To justify each expense, a deep understanding of activities/ projects is essential. This involves breaking down operations into granular tasks, understanding their purpose, and evaluating their contribution to overall business goals.
2.	Direct and transparent communication	Nurture clear, direct and open communication and create a culture of transparency throughout the organisation regarding the ZBB process	Ensure that all stakeholders understand the objectives of ZBB and how it aligns with the organisation’s strategic goals. Clear communication helps in gaining support from employees and managers, reducing resistance to change.
3.	Prioritise based on strategic goals	Prioritise activities based on their alignment with strategic goals and objectives.	Link budget allocations to the importance of each activity in achieving organisational objectives. This ensures that resources are allocated to high-impact areas and helps maintain focus on strategic priorities.
4.	Regular monitoring and evaluation	Implement a robust monitoring and evaluation system throughout the budget cycle.	Regularly review actual performance against budgeted expectations. This allows for timely identification of variances and enables adjustments to the budget as needed. Continuous monitoring ensures that resources are optimally utilised.
5.	Continuous Process	Integrate ZBB into an ongoing, continuous planning and budgeting process.	Instead of treating ZBB as a one-time event, make it a part of the organization’s culture. This involves regularly reviewing and justifying expenses, adapting to changes in the business environment, and ensuring that the budget remains aligned with evolving strategic priorities.

Implementing zero-based budgeting requires a cultural shift and commitment from all levels of the stakeholders. These best practices can help not just organisations, but individuals and governments navigate the challenges of ZBB and derive maximum benefit from the process.

Conclusion

Zero-based budgeting is essential for businesses and individuals today. It gives you a very detailed view of your spending, involves allocating funds into many different categories, and improves savings. However, you can consult an expert for effective budgeting and financial forecasting.

Adoption rates and success with ZBB can vary across industries. Certain sectors, such as consumer goods and retail, have been early adopters of ZBB due to its focus on cost efficiency. However, other industries, like healthcare or government, might face unique challenges in implementing ZBB.