Budgeting, forecasts, and financial analysis are usually painful exercises for marketing and sales departments. As professionals in these domains are focused on their main deliverable — to drive revenue — they are usually not keen to spend a lot of time budgeting and analyzing numbers.
Now imagine, instead of going for the incremental budgeting approach where departments only have to justify the total amount, the budget is to be prepared from scratch. Will each activity be judged on its merit rather than experience? It would surely bring new challenges for the business. At the same time, it optimizes resources as each business activity is considered per the business's current needs. Building the budget from scratch each year is known as zero-based budgeting (ZBB).
If implemented thoroughly, zero-based budgeting can improve resource allocation, employee engagement, and collaboration across the organization. The concept of zero-based budgeting is often seen with a myopic lens of saving costs. However, in reality, a zero-based budget essentially works toward solving problems, challenging assumptions and ensuring spend aligns with the business's current objectives. If there is a gap between resource allocation and business objectives, the organization can change course to achieve better alignment well in time.
Here is your ultimate guide to zero-based budgeting:
What is a Zero-Based Budget?
Preparing a zero-based budget is a cost discipline under which the organization is expected to prepare its budget from the ground up each year rather than relying on experiences in the past. The zero balance or budget allocates funding to each business activity based on necessity and efficiency rather than budget history. The management is expected to look at each budget head and decide on the importance and money to be spent on each function for the efficient functioning of the business.
The zero-based review methodology focuses on each budget item individually based on its contribution to business goals and cost-efficiency.
Zero-Based Budgeting Process Steps
Now that you understand what ZBB is, it is time to look at how you can get rolling at your organization. Here are the steps that you can follow to get started with the zero-based budgeting implementation in your organization:
Start the Process
In a zero-based budget exercise, you are expected to always start from the ground up. You should discard all preconceived notions about various departments and activities in the first stage. At the same time, you should prepare to start from zero.
Evaluate Each Activity
The ZBB methodology requires enterprises to evaluate each activity from a fresh perspective and not from the burden of the past. For instance, rather than increasing the manufacturing budget because the vendors are increasing costs, you should look at the possibility of making it in-house.
Prepare the Justification
Each budget item and its corresponding cost need adequate justification in a zero-based budget. As you get into the preparation mode, you should think about all budget activities on two broad aspects – their contribution to business objectives and the justification of the corresponding cost.
Streamline the Processes
Once the budget has been prepared, and proper justification has been provided, it is time to streamline the processes by looking at the time and scale of activities performed under the budget. At the same time, you should automate and standardize processes as much as possible to bring efficiency to operations.
Initiate the Execution
Once the processes have been streamlined, it is now time to roll out the comprehensive planning and execution process. In this stage, you are expected to communicate clear plans, responsibilities, and roles of each individual in the organization.
Zero-Based Budgeting vs. Traditional Budgeting
Zero-based and traditional budgeting are two completely different ecosystems under which an organization's budget is prepared. Here are the significant differences between zero-based budgeting and traditional budgeting:
Zero-based budgeting focuses on keeping in the budget, while traditional budgeting focuses on what to remove.
The scope of a zero budget is much broader than a traditional budget. In zero-based budgeting, the organization is expected to look at each cost separately, while traditional budgeting only handles incremental costs.
The primary consideration in a zero-based budgeting is to decide the activities to be performed in a given time period under the set budget and their roadmap. In contrast, a traditional budget focuses on improving how the activities are performed.
Level of detail
The level of detailing is much more in ZBB than in a traditional budgeting system. As you look at various budget components and decide on their effectiveness and requirements, it is much more detailed than a traditional budget.
Additional Read: Zero-Based Budgeting in Procurement
Advantages of a Zero-Based Budget
There are several advantages of zero-based budgeting. Some key advantages of ZBB include:
As each budget item is evaluated, the budget is prepared from a fresh perspective. This helps in justifying each activity in the budget.
ZBB increases collaboration within the team as various departments need to communicate and arrive at a beneficial budget for the organization.
Zero-based budgeting helps in improving the efficiency of a business. Be it in finance, operations, or execution, ZBB helps in improving processes.
Chance of Cost Reduction
With a focus on each activity, ZBB gives a better chance at reducing the overall cost.
Disadvantages of a Zero-Based Budget
ZBB is not without its disadvantages. Let’s look at the disadvantages of zero-based budgeting:
Preparing a zero-based budget can be a time-consuming activity compared to a traditional budget. For companies with limited resources, it can be an additional burden.
You need to have qualified personnel with adequate training to execute zero-based budgeting efficiently. All this adds up to the costs of the organization.
Preparing a zero budget efficiently is easier said than done. It is a complex activity that needs to be handled with care.
The focus on a zero-based budget can be limited to revenue generating activities such as sales and marketing rather than long-term activities like training, research and development.
Zero-based budgeting is an effective exercise for companies looking to reduce costs and create a budget with participation from all departments. With all the advantages of a zero-based budget, you should also consider the drawbacks before making a final choice.
A zero-based budget can potentially alter the cultural fabric of the organization. As there is immense focus on each cost component, an organization's positive and vibrant culture may struggle to grow in the zero-based budgeting phase. Read more to learn how GEP can help your business with zero based budget consulting.