Posted by Shivali Anand
August 18, 2021 | 6-minute read (1108 words)
Over the last several years, zero-based budgeting has garnered a lot of attention. Consumer goods companies were among the first to use zero-based budgeting in the 19070s as a growth accelerator, but the practice fell from favor in the following decades. But zero-based budgeting has since made a comeback, spreading to more industries as companies strive to maximize value and promote sustainable change.
What is zero-based budgeting, and why are so many businesses talking about it?
In addition to being a “bottom-up” strategy, zero-based budgeting is a sustainable cost approach that helps businesses reset their cost base by finding wasteful expenditures that can be better allocated elsewhere.
A company's cost basis is reset, and its long-term leanness is ensured using zero-based budgeting. This allows the business to invest in long-term sustainable growth possibilities, such as product development and innovation. Cultural change is also required to implement zero-based budgeting.
What Is the process of creating a zero-based budget?
Each period in an organization's calendar is budgeted fully concerning the expenditures and demands for that period, which can be for a month, a quarter, or a year, starting from a zero base — with no spending or balances carried over (whatever works best for a business).
Regardless of whether the budget was larger or lower during the previous period, the justifiable costs and financial requirements are considered the significant inputs for the company's budget at the start of a new period. When the following period starts, you restart from zero bases and continue the procedure.
Zero-based budgeting versus traditional budgeting
The zero-based budgeting strategy stands in opposition to the traditional annual budgeting process. A standard yearly budget often adds a few percentage points to the previous year to adjust for inflation and salary increases. Inefficiencies and lost chances for additional cost savings might result from this sort of incremental planning.
Zero-based budgeting requires businesses to create their annual budgets from scratch (zero) every year to ensure that all components of the yearly budget are relevant and cost-effective and produce more significant savings.
For example, if a business anticipated a 5% increase in output, say, due to a new client, it would simply add 5% to the budget from the prior quarter. This cost-based budgeting assumes that all past production and operational costs are necessary and then proceeds forward with sustaining the funding for those services without additional examination.
However, with zero-based budgeting, every cost must be justified for every month; as a result, all recurrent expenses are examined before approval and are either modified or terminated depending on need.
Is zero-based budgeting the right choice for you?
Zero-based budgeting effectively means that it allows you to handle what is going on in your organization right now instead of making decisions based on previous, out-of-date patterns. However, it is not a one-time activity and may not be suitable for many businesses. As a result, before choosing if zero-based budgeting is ideal for your firm, consider the following benefits and drawbacks.
Let's start with the advantages:
Now, let's look at the disadvantages:
- Zero-based budgeting is excellent for cost-cutting since you have complete control over how much you reduce. While this technique allows you to be proactive in lowering costs, you have complete control over how much you reduce and where you reallocate cash.
- Historical patterns are essential when developing a budget, but they do not provide a clear picture of overall spending. Zero-based budgeting demands you to evaluate all budget operations to ensure that money is dispersed in the most effective way possible — based on current requirements rather than historical trends.
- While starting from zero every time may sound like a lot of work, and you can develop a systematic approach to zero-based budgeting by allowing your organization's executives to engage in the process and provide expert views about the budget's activities.
- Zero-based budgeting is more than just a budgeting approach; it's a tool for eliminating all inefficiencies in your company. It helps you eliminate away operations that are harmful to your organization's performance by looking at each activity with the decision-makers in each department.
How can you implement a zero-based budget?
The seven stages below can serve as a starting point for implementing zero-based budgeting:
Start: Begin by creating a new yearly budget from scratch without utilizing last year's inputs as a reference point.
Examine: Examine every aspect of cost. Remove or reduce non-essential activities or services.
Account for: Justify all budget components. Identify cost-saving areas that are both relevant and cost-effective.
Streamline: Determine which tasks should be completed and how they should be completed. If at all feasible, standardize and automate your procedures.
Implement: Ensure that all planning and execution processes are followed to the letter. Plan, procedures, roles, and duties should be simple to communicate.
Re-examine: If any errors were made, make the necessary adjustments, continue with the procedure in the following session, or eliminate the task(s).
Start again: At the start of a new period, start over at the first step (annual in this case).
Consider the following points:
Zero-based budgeting necessitates a thorough rethinking of your budgeting approach. So, before you start, do your homework and get a clear picture of the scope of the change within your company. Make a detailed list of what you intend to accomplish.
Making the switch to zero-based budgeting will have ramifications across the organization's procedures and operations. Ensure that your company's senior executives know the advantages, understand the need for change and are willing to push the change across all departments.
Take the time to assess the degree of the shift in all aspects of your company. Make sure you've considered the method, the final result, and how you'll get there. If necessary, get assistance from a third party who can advise you on the best course of action.
Bring your department leaders on board and include them in the process of achieving your objectives. Keep them informed about the rationale for the change and make sure everyone is aware of the consequences.
- While zero-based budgeting can help you establish repeatable procedures, it can also take longer than traditional planning.
- Even if you can persuade your department heads to work with you, they may not be able to estimate their demands for the full budgeting term accurately.
- Fixed expenses in a contract, such as a building lease, maybe overlooked throughout the budgeting process.
- Even though a cost may not appear to be critical to your company's operations, it may have an adverse impact on the customer's experience.
- If you operate a large business, zero-based budgeting may be too costly and demand too much effort from other departments to be effective.