Once considered an “extreme” method for FP&A teams, zero-based budgeting (ZBB) is becoming the new normal for businesses that rank efficiency as their top priority. But is it the right methodology for yours?
The answer is yes; however, only if you’re fully informed about how to factor it into your overall strategy, as well as how to ensure you’re equipped with the best budgeting and forecasting software to keep every wheel of your strategy running smoothly 24/7.
This article will explore what zero-based budgeting is, how it works, and why modern finance teams are increasingly opting for this approach.
What is zero-based budgeting (ZBB)?
Zero-based budgeting (ZBB) is a methodology to help align company spending with strategic goals. Its approach requires organizations to build their annual budget from zero each year to verify all components of the annual budget are cost-effective, relevant, and drive improved savings. Its five main characteristics are broken up into:
- Focus: The focus of efforts on both “how much” a single unit will incur, as well as the “why” behind it incurring
- Decisions: Decisions are based on what each unit can offer at the given cost
- Objectives: The individual unit’s objectives are aligned with overarching corporate objectives
- Adjustments: Immediate adjustments in the budget are always possible if required
- Levels: All levels of an organization participate in the decision-making process
This approach is gaining more prominence amongst modern finance teams as organizations look to optimize their budgeting process and get the most out of their spending.
Zero-based budgets vs traditional budgets
A traditional budget typically builds off of the prior year’s budget and focuses on incremental improvements. This means organizations are likely to include line items that are no longer necessary or are no longer cost-effective.
A zero-based budget, on the other hand, requires a more rigorous assessment of the entire budget and requires organizations to justify each line item: it’s an approach that requires organizations to prioritize their spending and can help them identify areas where they can reduce costs or optimize their spending.
Because teams who utilize a zero-based budget justify their budgeting decisions based on efficiency, return on investment (ROI), and impact vs. historical budget decisions, it is now widely viewed as the more modern approach to running company budgets–and the preferred method for goal-setting CFOs.
Advantages and disadvantages of zero-based budgeting
Zero-based budgeting has the potential to bring a number of benefits to finance teams and their organizations.
One of the main advantages of ZBB is that it helps to ensure that money is spent on activities that drive better profitability and performance. This is due to the fact that ZBB requires all parts of the annual budget to be justified every year. Resources are only allocated to activities that are cost-effective and relevant to an organization’s strategic goals.
ZBB is also agile; organizations are able to quickly adjust their budget if required and adapt accordingly, which is particularly useful in fast-moving markets where circumstances can change rapidly.
However, there are also some potential drawbacks to be aware of. One of the main disadvantages of ZBB is that it can be time-consuming and require a lot of resources. This is because of the need to build the annual budget from zero every year. ZBB can also be difficult to implement in larger organizations due to the need for collaboration and information sharing.
Finally, some organizations may find that ZBB does not fit with their existing budgeting process. In this case, it may be worth considering an alternative approach.
Examples of a Zero-Based Budget
As part of a finance transformation, there are a variety of examples of a zero-based budget.
One such example is as follows: if a small business takes home $3,000 per month, on a zero-based budget, you would allocate the entirety of that money to bills, savings, and spending. At the end of the month, you have $0 left.
With a zero-based budget, if you underspend in one category of your business, that unspent money will be reallocated to another category. On the other hand, if you overspend in one category, you’ll have to find money from another category to make up for it.
Which types of companies use ZBB and why?
Among the businesses using zero-based budgeting in 2023 and beyond include, but aren’t limited to:
- Auto manufacturer General Motors Co.
- Industrial firm Honeywell International Inc.
- Cosmetics business Coty Inc.
- Chocolate maker Hershey Co.
- Alcoholic-beverage company Diageo PLC
- Hewlett Packard Enterprise Co., a provider of cloud-based IT solutions.
As this wide variety of successful companies demonstrates, zero-based budgeting can be a useful tool for modern finance teams in a number of scenarios. For example, it can be used when an organization is looking to optimize spending and ensure that money is only allocated to activities that are cost-effective and relevant to their strategic goals.
ZBB can also be useful when an organization is looking to introduce more transparency into its budgeting process. All parts of the annual budget need to be justified each year, and ZBB can help to ensure that resources are only allocated to activities that are in line with an organization’s strategic goals.
The step-by-step process of creating a ZBB strategy
Creating a successful ZBB strategy requires careful planning and a clear understanding of how the approach works.
To help you get started, here is a step-by-step process of how to create a well-rounded ZBB approach to budgeting:
- Set Your Objectives. Start by setting clear objectives for your organization. Consider how your budget can support these goals and ensure they are aligned.
- Plan Your Process. Develop a clear process for creating your budget. Outline the timeline and involve relevant stakeholders to ensure a thorough and efficient process.
- Divide and Conquer. Break down your budget into specific components to better understand where your funds are being allocated. This will help you identify areas that may need more investment or those that can be reduced.
- Scrutinize Your Spending. Analyze each component of your budget in detail, looking at the costs associated with each item and how it supports your objectives. Identify areas where spending can be optimized.
- Make Necessary Changes. Based on your analysis, make any necessary adjustments to your budget. Consider areas where you can reduce costs or where additional investment may be needed.
- Allocate Resources Effectively. Once your budget is finalized, assign the necessary resources to ensure successful implementation. Consider personnel or other resources that can support your objectives.
Best practices for zero-based budgeting
For modern finance teams who are looking to implement ZBB, there are a number of best practices to bear in mind.
First and foremost, it's essential to involve all stakeholders in the process. This includes everyone who will be affected by the budget and those responsible for making decisions. Ensuring everyone is on the same page guarantees that decisions are made with the organization's overall goals in mind.
Transparency and documentation are critical components of the budgeting process. Maintaining clear records of all decisions ensures that everyone is aware of why particular choices were made and how they impact the overall budget.
Performance monitoring is also crucial for keeping the budget on track. Regular reports provide a way to monitor performance closely and make quick adjustments when necessary.
Ultimately, data should inform all budgeting decisions. By using data to allocate resources, teams can make more informed and intelligent decisions that benefit the organization as a whole.
Best software for zero-based budgeting
With Pigment, FP&A teams can build, maintain, and visualize reports, plans, and forecasts in real time. Get rid of common constraints by utilizing our natural syntax, live updates, easy-to-explore formulas, and collaborative budgeting and forecasting software.
- View and track all key metrics in real-time via easy-to-read reports
- Eliminate number-crunching and modeling constraints so your team can focus on value-added analysis
- Get a 360° view of your business to make better decisions
For FP&A managers and analysts:
- Import, clean, and enrich data from all your business apps in seconds
- Model in just hours, not days
- Change and improve your model over time, ensuring data integrity and preventing errors
- Run what-if scenarios on the fly to help your decision-makers drive business strategy
Remember: it’s not all about cutting costs. Now that you’re an expert on all things ZBB – including how to create a zero-based budgeting strategy and how to leverage budgeting and forecasting software to make planning a breeze – read our CFO State of the Market 2023 Report to learn about what else is top of mind for CFOs in 2023 and beyond.