Traditional approaches to business budgeting often rely on adding or subtracting from previous budgets according to anticipated changes over the coming period. While this approach can provide reasonable budgets, it can also instill the wrong mentality in employees.
With the traditional approach to budgeting, people try to make sure they’ve spent their budget so next year’s budget will be the same or increased.
While important financial metrics and returns on investment are still at the forefront of a budget, the traditional approach can lead to waste or diminished value. At the same time, it creates or reinforces a mindset and culture aimed at meeting the budget rather than critically assessing costs.
Zero-Based Budgeting (ZBB, also known as zero balance budget and zero-based costing) is a new way to approach budgeting that overcomes the challenges that arise from typical budgeting strategies. In this article, we’ll explore benefits of implementing ZBB, including how it can help improve your company’s bottom line and internal company culture.
What is Zero-Based Budgeting (ZBB)?
At its core, ZBB is a fundamental shift in the way companies approach budgeting. Whether it’s specific project budgets or annual budgets for a department or company, ZBB shifts the way companies and individuals assess spending. Rather than rely on previous spending, ZBB requires a “start from zero” mentality – look at the budget on its own and review costs.
Zero-based budgeting has wrongfully gained a reputation as an approach solely aimed at cutting costs.
The main goal of deploying zero balance budget is to increase value and ROI. By critically assessing all aspects of a budget, rather than just looking at last year’s budget and adding more for inflation or to account for cost increases, a company can better control their costs as they grow.
When a company begins developing a ZBB budget, its mentality shifts from looking at costs merely as an expense and instead requires justification: what value will that cost bring to the project/department? How does that value speak to our broader mandate or objective? Does this improve our deliverables? All these questions should be asked as you go through the budgeting process.
ZBB does not mean starting from scratch, just starting from zero. This is an important distinction: traditional approaches to budgeting start with historic figures and factors as the basis of the budget. This means that the ultimate justification for the budget at the end is based on history rather than the current situation, and costs typically do not need to be justified beyond this.
ZBB doesn’t mean that you can outright ignore previous budgets and costs; in fact, in many cases history should be a key consideration for a ZBB approach.
The main difference is that history can’t be the main determining factor; value for money needs to be a focal point for zero-based budgets. This is what that the concept means by “starting from zero”: all costs are justified for the upcoming period regardless of how money has been previously allocated. Traditional budgeting makes assumptions about spending and allocates from there, while ZBB can use historic information to inform but the costs will still need to be validated and justified independent of the historic information (i.e. they need to demonstrate that those costs will translate to value in the current period).
Zero-Based Budgeting Varies in Practice
Like other management methodologies, such as Lean and Agile/Scrum, ZBB can take on many forms in practice. If the core of ZBB is maintained (starting from zero), the methodology can be deployed in many ways. For some organizations, they may simply need to develop budget justification processes that reflect the core of ZBB; in others, a full implementation of the approach may be more appropriate. Most commonly, hybridized approaches to budgeting allow companies to efficiently create and manage a budget while also justifying the costs for value.
ZBB detractors highlight the bureaucracy and amount of time it takes to create and manage as a limiting factor.
While the exercise can be very time intensive and bureaucratic (creating new processes with decision-making hierarchies), ZBB does not necessarily cause this. Companies can maintain many of their existing budgeting processes but emphasize a shift in how to approach value and outcome. Even requiring a forward-looking justification of costs will help improve budget development and control costs.
Fear of cost-cutting drives people to spend their budget. They’ll look at their current allotment of funds of money and know they must show that they spent very close to, or just above, budget to justify the same amount or more in next year’s budget. This leads to a potentially wasteful mindset at worst, and a focus on spending rather than value at best.
ZBB helps eliminate this mindset and shift individual employee’s thinking more towards the value for money.
ZBB is mainly a cost-controlling approach to budgeting. As companies grow, they quickly find selling, general, and administration (SG&A) costs increasing in step with revenue. In a manufacturing environment, cost of goods sold (COGS) can be improved over time through scaling, automation, lean production methodologies, etc. Zero-based costing can help virtually every type of business better understand and manage spending. This approach helps empower individuals throughout the company to justify the value of spends and their overall contribution to the company. While ZBB is best-suited for profit centres within an organization, it can be deployed throughout a company.
Towards a Value-Centred Mindset
In smaller organizations and startups, every employee is usually involved in cost considerations. Every expenditure is justified on its own merit and by how well it contributes to the growth of the company. In financially constrained organizations, this mentality is fully engrained, and employees always look at value for money.
In larger organizations, this is not necessarily the case as individuals are farther and farther away from a profit and loss (P&L) statement. Traditional approaches to budgeting simply look at the total amount allocated in previous years and not at the specific value costs contribute to the organization. By adopting zero-based budgeting, a company can provide more decision-making capacity and ownership over expenditures, helping employees adopt a value-centred mindset.
ZBB doesn’t necessarily mean cost-cutting and minimalizing spends.
Many companies shy away from ZBB because they don’t want to slash and burn their departments or focus exclusively on expenditures at the cost of doing the work efficiently and effectively. Focusing on value doesn’t mean that businesses need to emphasize doing it cheaper or with fewer resources – it simply means the resources allocated need to be aligned with increasing value.
The ZBB mindset doesn’t rely on a company fully adopting the processes or overhauling their entire approach to budgeting. Rather, by requiring cost justifications during the budgeting period, it can help people to think more critically about spending. By tying the justification of the cost to value, budgets can be more informed and better aligned with an organization’s broader mandate.
Benefits and Drawbacks of Zero-Based Budgeting
ZBB can be a very powerful tool in re-aligning employees with expenditures and value. It can help reduce costs, increase ROI, and support broader company growth. There are, however, some drawbacks to ZBB. Mainly, the process is intensive and can be time consuming. If an organization is rigid in their processes, it can be hard to adopt and very disruptive. While it could be potential short-term pain for long-term gain, ZBB can also have its opposite intended effect and create large complex processes to manage.
I always advocate for contextualizing all business decisions, and the use of historical data is critical in all aspects of organizational decision-making. For organizations that are seeing cost increases and looking for efficiencies, ZBB can be helpful. It’s worth trying the approach on a small project first before adopting it throughout the entire organization.