Zero-based budgeting (ZBB) is a simple concept that has been around since the 1970s. Fundamentally, it proposes that instead of relying on historic spending data to forecast budgets, start at zero and build budgets solely based on costs with a justified need. Much has changed in the business world since the introduction of ZBB, including operational practices, workplace cultures, and financial management technology.
In ZBB, budgets are not linked to prior year spend – they are built from the bottom up. To fully justify all expenses, managers need to routinely review the most cost-effective way to deliver their activities, programs, and levels of service; keep their resources in step with workload; and eliminate any expense that is not aligned with strategy. ZBB is not just about cutting costs. By eliminating wasted and unproductive spending, ZBB frees up cash that can be reinvested to fund organic growth or acquisitions. As such, ZBB can be a catalyst for growth. ZBB is becoming the accepted go-to approach for any company struggling to maintain margins at a time when prices are largely capped.
Because of its ability to quickly restructure the costs of new acquisitions, ZBB has always been favored by private equity firms that need a quick turnaround. But it is also gaining adherents with manufacturing, advertising, and hospitality companies. Continuing severity in government funding has also led to a renaissance of ZBB in the public sector.
If you’re new to ZBB, or haven’t used it in several years, here are the four best practices to achieve success.
- Adopt a positive approach
ZBB is more than just reducing costs. It’s a necessary step for freeing up the resources and funds needed for business renewal and growth initiatives. Working with the business leaders, you can use internal and external benchmarking to illustrate profitability gaps that need to be closed and explain exactly what will happen to the savings.
- Identify the quick wins
Initially focus your ZBB initiative either on the larger and more stable business units that are struggling with profitability or selected areas of overhead such as sales, general, and administrative expenses, where there are large amounts of indirect cost that are not clearly understood. Such choices will not only help reinforce the rationale for undertaking ZBB, but they will also deliver the largest cost savings with minimal disruption to the rest of the organization.
- Select the right planning platform
The success of ZBB depends on having detailed insight into the operational drivers of costs, such as activity volumes, productivity ratios, and input costs – none of which is contained in traditional planning and budgeting software. These older systems only contain highly aggregated, financial data and as a consequence, need to be supplemented with considerable amounts of data from elsewhere, such as spreadsheets. However, manipulating this data in auxiliary spreadsheets increases both the complexity and workload involved in any ZBB initiative.
- Plan for sustainability
Move on to other business units or expense categories and revisit previous projects to ensure the savings once you have implemented a successful ZBB project. Don’t decommission your ZBB model either. Since it contains the casual relationships between different activities, resulting resource needs, and expenses of those needs, the ZBB model can easily be developed into a driver-based planning and budgeting model that could beneficially supplement or replace existing Financial Planning and Analysis (FP&A) processes.
Using these four best practices and the flexible and easy-to-manage planning platforms available today have reduced the complexity and costs of undertaking a ZBB project. Any successful ZBB project should result in a heightened awareness of cost control. It’s probably true that every company could benefit from at least trying ZBB. Especially with modern technology and tools, ZBB enables more inclusive and informed decision-making about investments, and it helps participants be more accountable for their decisions. Take a broad approach supported by executive sponsorship in order to lead to more strategic and successful ZBB program results.