Zero-based budgeting (ZBB) is a budgeting technique in which all expenses must be justified for a new period or year starting from zero, versus starting with the previous budget and adjusting it as needed.
ZBB is a highly effective business-planning tool to help a company identify and eliminate unnecessary costs, keep control of your spending, and focus on high-profit initiatives.
Budgeting, including ZBB, is the tactical implementation of a company’s strategic plan. To deliver the financial and operational goals in the strategic plan, an organization needs to translate its long-range plan into a detailed set of expected revenues and expenses that can be measured to track performance. These can be refined and adjusted along the way to keep the company on track with its goals to achieve the desired business outcomes.
Above all, budgets enforce ownership and accountability so that financial decisions are made sensibly. They help companies project profits, spot potential problems, and identify new opportunities so that finance leaders can make the necessary adjustments.
|Traditional budgeting||Zero-based budgeting (ZBB)|
|Based on the previous year’s budget||Started from scratch (zero base)|
|Based on previous expense levels||Requires new expenditure justification|
|Justification is not typically required||Cost and benefit justification required|
|Management decides on expenditures||Line(s) of business management propose expenditures|
|Less clarity and responsiveness||Greater clarity and responsiveness|
The typical budgeting process is translating a long-range strategy into annual operating plans that are pushed down to finance, lines of business, and operations. This communicates the financial targets across the organization in every line of business. The targets can be financial and operationally aligned. Some examples of this are revenue and expense budgets, R&D costs, marketing expenses, project costs and revenues, and capital expenditures.
The budgeting process requires analyzing and comparing actual versus expected financial performance to determine how to allocate expenditures for the organization to achieve the budget targets set.
With traditional budgeting, the process of projecting your business’ revenue and expenses for the upcoming year is typically based on your previous budget which is used to help predict, analyze, and track revenues, expenses, profits, and cash flows. Traditional budgeting calls for incremental increases over previous budgets, such as a 2% increase in spending, as opposed to a justification of both old and new expenses, as called for with zero-based budgeting. Traditional budgeting only analyzes new expenditures, while ZBB starts from zero and calls for a justification of old, recurring expenses in addition to new expenditures.
Zero-based budgeting was developed in the 1970s by Pete Pyhrr, a former accounting manager with Texas Instruments. The original goal of ZBB was to help organizations reduce costs and promote fiscal responsibility.
With zero-based budgeting, the budget is started from scratch or a “zero base” each year. Using this approach, every line of business within an organization is analyzed for its needs and costs while ignoring historic spending. The key difference is justification: Zero-based budgets need to review every expenditure at the beginning of the budget cycle, and lines of business have to justify the need and impact of each line item before funding can be approved.
Each budget line item is reviewed without the influence of the last period’s actuals as a baseline. Each item is carefully evaluated to determine if any programs, services, or activities will be increased, maintained, reduced, or removed. Managers need to account for all elements of the budget and identify cost-effective, relevant, and cost-saving areas.
ZBB can be applied to any type of cost: capital expenditures, operating expenses, research and development (R&D) expenses, or even cost of goods sold (COGS).
ZBB has many advantages over traditional budgeting. It has a bad reputation for being a complete cost cutting exercise, but ZBB an help you align spend to more revenue generating opportunities. ZBB offers a number of advantages, including lower costs, budget flexibility, and strategic execution. When every expense is carefully scrutinized, the highest revenue-generating activities are prioritized. Expenses are often reduced because ZBB helps to prevent the misallocation of resources that happens when a budget grows incrementally over time.
While ZBB can be an effective budgeting strategy, it can also be quite challenging to implement. Since budgets are created from scratch, it’s much more time-consuming than traditional budgeting. The unintended consequence of ZBB is that it can promote short-term cost savings over long-term benefits. In an effort to minimize costs, some key expenses, such as research and development or long-term strategic projects, may get overlooked.
ZBB is more than just slashing costs. It’s a necessary step for freeing the resources and funds needed for growth initiatives. Working with the line of business leaders, you can identify overspending and reallocate those resources toward more strategic use.
To reap the benefits of zero-based budgeting, modern planning and budgeting software is essential. Cloud-based planning solutions that use AI and machine learning can help managers make data-driven decisions to recommend the best path forward. A planning and budgeting solution should not only be a blank canvas for modeling: it should also contain planning intelligence and purpose-built capabilities for predictive planning, driver-based budgeting, robust “what-if” scenario modeling, sandboxing, top-down and bottom-up budgeting, and approvals and workflows as best practices that are readily available.
Siloed, line of business planning might have sufficed before, but today the focus is about connected and continuous planning across the enterprise. Disruption has become a constant, and plans are now made to be changed, refined, and adjusted continuously. Successful CFOs are partnering with sales, marketing, HR, and operations to make faster decisions using connected, accurate, and timely information. In this new world, connected enterprise planning is not just a best practice—it is a necessity.
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.
Above all, ZBB allows businesses to identify cost savings, reallocate those savings to more strategic use, and fuel sustainable growth.