Zero-Based Budgeting: What It Is and How to Use It

Over the past 12 months, the COVID-19 crisis has forced business leaders to double down on cost management, ensure liquidity, and scrutinize budgets. Apart from prompting short-term contingency measures—such as cutting back on marketing budgets or IT projects—the lockdowns have spurred cost reductions. Just consider the dramatically lower spending on travel that has accompanied the shift from physical meetings and events to virtual ones. As an accounting practice, zero-based budgeting offers a number of advantages including focused operations, lower costs, budget flexibility, and strategic execution.

It’s also helpful if you’re trying to get out of debt and need to allocate extra money toward your debt payments. Because every dollar is accounted for, you’re less likely to waste money. This can help you reach your financial goals much faster because you know where your money is going.

  1. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.
  2. Plus, they knew they had the resources under them to support that from a visibility and a governance standpoint.
  3. Implementing zero-based budgeting is not solely an accounting decision and must be considered in conjunction with the company’s overall business strategy and goals.
  4. These factors make IBM Planning Analytics a preferred choice for organizations seeking to implement ZBB effectively and achieve cost optimization and accountability throughout the budgeting cycle.

The most significant cost to organizations is usually the initial time and staff effort spent in setting up the system. Over time, there is a risk that managers may feel threatened by the thought of minimal increments to their budgets; this is because it may imply cuts, which is damaging to departmental growth. This allows them to trade the expenditure on cost planning, maintenance, sales, and administration. Top management prepares a consolidated ranking to identify the best allocation of resources.

Myth five: ZBB is not designed for growth-oriented companies

Another firm might find that deploying ZBB in only one region or one business unit suits its needs. What usually ends up happening, however, is that companies that start with a limited scope see great impact from ZBB and often decide to use it more broadly. Peter Pyhrr, an accountant and consultant, is credited with developing the concept of zero-based budgeting (ZBB) in the 1970s. Pyhrr recognized the limitations of traditional methods of budgeting that relied on incremental adjustments to previous budgets. He believed that organizations needed a more rigorous approach to budgeting that would ensure resources were allocated efficiently and aligned with strategic objectives.

In such scenarios, it does not make sense to look at last year’s budget because significant changes in the company’s situation have taken place. The entire budget needs to be redone from scratch zero based budgeting forces managers to – hence, a zero-based budget. Add your monthly expenses to the amount of money you’d like to save each month. You have a zero-based budget if the result is zero or very close to it.

It’s a process that’s embedded in the normal financial-planning and management routines. It’s a set of systems that, first, give you visibility to where you’re spending money and where your resources are today and allows you to compare that to where they should be [Exhibit 1]. Then it provides better visibility to where you’re spending, so that you can have better dialogues with the management team.

Instead of relying on the previous year’s budget, ZBB requires you to evaluate and justify every expense from the ground up, justifying its necessity and alignment with strategic goals. It’s like starting with a blank canvas and carefully selecting each budget item based on its value and contribution to your financial objectives. Zero-based budgeting is much more than building a budget from zero.

What is zero-based budgeting?

ZBB starts from scratch each year and places less emphasis on what was budgeted in the past. In the traditional approach, it is assumed that all previous activities are essential for achieving the ongoing objectives. Zero-based budgeting, primarily used in business, can be used by individuals and families, too. With margins under pressure, this approach can reduce costs as much as 25% and ensure they don’t creep back. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

The next element is an external review process that involves someone who is not part of the manager’s organization.The third element is a detailed cost-accounting system. The fourth element is a “preponderance of proof” standard, which means that managers have to justify their expenditures as reasonable and necessary.Lastly, zbb is a continuous process that managers must follow each year. Zero-based Budgeting (ZBB) is a management process that requires managers to justify all expenses in budget categories. This is the case regardless of whether or not expenditures had been made in previous years.It forces managers to review their budgets and propose new solutions, rather than continuing on with past practices–hence the term “zero-based.” Pyhrr introduced the idea of starting the budgeting process from a “zero base,” meaning that every expense had to be justified from scratch. This approach challenged the assumption that previous spending levels were automatically justified, requiring individuals and departments to provide a detailed rationale for each expenditure.

Business Transformation

Zero-based budgeting is a powerful tool for any company, whatever its orientation. Even if the organization’s primary focus is on growth, profit, or talent retention, cost management remains crucial to its success. Eliminating unproductive costs allows the company to be redirected to more productive areas. As we mentioned in the earlier example, back-office costs can be redirected to customer-facing activities.

The point is to challenge budgets and spending from the bottom up in order to assess whether they support business priorities. Zero-based budgeting is an innovative type of budgeting that challenges conventional financial practices. By reevaluating expenses from scratch and aligning them with strategic objectives, ZBB promotes cost optimization, efficiency, and accountability. While implementing ZBB requires significant effort and change management, the benefits of this approach can outweigh the challenges.

And the insight that they gain into where the money is going enables companies to reverse the burden of proof at budget-setting time. Instead of an approach in which the controlling function argues against allocating a certain amount (and all too often lacks the data to back up its argument), the budget owner makes the case for the expenditure by providing proof of its value. Over time, as defending costs on the basis of return and value becomes ingrained behavior, decision making becomes faster and more efficient.

Boston Consulting Group partners with leaders in business and society to tackle their most important challenges and capture their greatest opportunities. BCG was the pioneer in business strategy when it was founded in 1963. Today, we work closely with clients to embrace a transformational approach aimed at benefiting all stakeholders—empowering organizations to grow, build sustainable competitive advantage, and drive positive societal impact. Since such behavior is usually a rational response to a company’s internal dynamics, the company must create the right context if it is to overcome that behavior. Specifically, the company needs to orient itself so that it is in individuals’ self-interest to behave in the desired new ways.

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