Numerous businesses are shifting into recovery mode after the economic disruption caused by COVID-19. The crisis has forced business leaders to double down on cost management, ensure liquidity, and scrutinize budgets. Apart from promoting short-term contingency measures—such as cutting back on marketing budgets or IT projects—the situations 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.
Although hopes remain high that the crisis will end soon, heightened volatility and uncertainty are undoubted. This raises several critical questions: How do organizations rethink their resource allocation and budgeting process going forward? How can they preserve the tactical savings they have captured over the past year? And how can they harness and translate these behavioral changes into sustainable savings— and avoid the cost creep that invariably occurs when cost-cutting programs become fixtures?
There's a particularly effective way to change how organizations manage cost: through Zero-Based budgeting.
Zero Based Budgeting Overview
Pete Pyhrr curated the idea of zero-based budgeting (ZBB) in the 1970s while he was an Account Manager at Texas Instruments, USA. Both Big Shots and private equity organizations have adopted this budgeting technique in recent years. A detailed study from Accenture Strategy on zero-based thinking published in 2018 found that from 2013 to 2017, this budgeting methodology grew exponentially among the world's 85 largest organizations at a rate of 57 percent every year. Those companies include Mondelez International Inc., Kraft Heinz Co., and Unilever PLC.
The primary purpose of ZBB is to align organizational spending with the company's overall strategic vision. A ZBB approach requires organizations to build their budget from zero in each period and validate all components in the budget that are necessary and aligned with the organization's strategic goals. Companies of all sizes and in different industries have reported solid results with ZBB, including increased profit margins and changes in how line-of-business (LOB) leaders and other non-financial managers think about spending.
Difference Between Zero Based Budgeting and Traditional Budgeting
|It does not consider the previous year's budgets or the years prior. It always starts budgeting from scratch, which is zero. This means constantly looking at budgeting with a fresh outlook and not having any assumptions and targets from previous years.
|It involves tweaking budgets made in the past by making adjustments so they are close to the actual expenditures in the business. Traditional budgeting always considers what was done previously and how it was done.
|Zero-based budgeting needs justification of expenditure. Every investment is accounted for in this type of budgeting, making it more thorough and realistic. It involves high visibility into the various cost drivers making this budgeting a more sustainable cost reduction approach.
|Traditional budgeting takes a moderate approach, and it is mainly utilized to drive revenue rather than find ways to decrease costs from individual units. It is not so specific about accounting for every money. It includes an increase in spending or cost reduction, but not to the minute level of zero-based budgeting.
|It needs more effort and time because everything is analyzed deeply before preparing a budget. Moreover, training is necessary to make sure that the budgeting is implemented in the correct way.
|It is generalized and needs less effort and time to create when compared to zero-based budgeting. Implementing traditional budgeting isn't as effort-inducing in comparison, thereby allowing every type of business to try it quickly.
|Zero-based budget spending decisions are made by managers. The spending depends on which activities are performed and how they should be performed so they can be cost-effective. The focus is more on optimizing costs rather than just revenue increases.
|Traditional budget spending decisions are taken by the top management of a business. It leans more toward how business activities should be performed. It doesn’t go deeper such as which activities should be given priority.
|It's better at connecting cost reduction with sets of business activities. This makes it much more transparent to implement and follow. It divides the activities as per the department it ought to be done.
|It is more about determining a change applied to all, such as increasing spending by 1%. This generic nature doesn't detail how the activities are tied to the budgets making it confusing to implement.
Benefits of Zero Based Budgeting
There is a range of potential advantages to the zero-based budgeting approach. With the proper implementation, ZBB will enable your organization to
1. Challenge the status quo: Zero-based budgeting encourages the business to take a hard look at what's working and what isn't across various processes and business activities. Cost centers may be redefined and activities examined to ensure finances are allocated most effectively.
2. Reduce costs while increasing efficiency: ZBB encourages department heads to seek to be more efficient, so increasing workloads actively do not drive increased spending – effectively determining how to do more with less.
3. Maintain control over the budget: Unlike traditional budgeting, where many budget holders roll over or inflate the previous year's budget without justifying why – ZBB encourages departments to review all aspects of their budget before submitting it. This gives greater control over budgets across the organization while potentially also helping to reduce inefficient spending.
4. Drive continuous improvement in activities: Instead of using previous budgets to form the basis of the next one, zero-based budgeting encourages managers to continually review their department's activities and determine where improvements can be made.
5. Encourage initiative and agility: To meet the demands of zero-based budgeting, department heads will need to be creative, agile, and take responsibility.
Zero Based Budgeting Best Practices
Much has transformed the business world, including operational practices, workplace cultures, and financial management technology. Check some of the best practices that organizations use to achieve success.
# Identify the quick wins
Typically, focus your zero-based budgeting initiative either on the larger and more stable business units toiling with profitability or selected overhead areas (such as sales, general, and administrative expenses) where high indirect costs are not clearly understood. Such choices will reinforce the rationale for undertaking ZBB, but they will also deliver the most considerable cost savings with minimal disruption to the rest of the organization.
# Build a culture of alignment and accountability.
As technology enables deeper visibility into what is driving costs and profits, organizations can use zero-based budgeting to align resources and investments more smoothly to strategic goals.
On the one hand, ZBB can shed light on opportunities for more strategic spending that have been overlooked or not considered worthy. According to the Harvard Business Review, one company used ZBB to determine that its commercial discount was higher than it needed to be—an expenditure that wasn't being reviewed. Another company used ZBB to solve a challenge specific to its logistics costs: labor costs were non-negotiable, but through a ZBB exercise, the company identified a way to reduce costs through negotiations with freight providers.
ZBB also can help to change minds about how spending should be planned. Instead of annual budget planning being a rote process based on traditional spending, each expenditure is scrutinized for what it brings back to the company. The process embeds accountability into decisions.
# Choosing the right planning platform
The success of zero-based budgeting depends on having in-depth insight into the operational drivers of costs like productivity ratios, activity volumes, and input costs—none of which are contained in traditional planning and budgeting software. These older systems only involve highly clustered financial data and, as a consequence, require to be supplemented with substantial amounts of data from elsewhere, such as spreadsheets. Manipulating this data in ancillary spreadsheets increases the workload and complexity involved in any ZBB initiative.
A preferred alternative is to hold all the detailed financial and operational data on a single financial planning and analysis platform like- Anaplan. Such a platform makes it easy to model the causal relationship between activity volumes and the resulting resource needs. Additionally, Anaplan's proprietary in-memory calculation engine provides the necessary power to process the large volumes of data involved.
It's probably true that every company could benefit from at least trying ZBB. Especially with modern technology, zero-based budgeting enables more inclusive and informed decision-making about investments, and it helps participants be more accountable for their decisions. Get in touch with Polestar Solutions to take a broad approach to more strategic and successful ZBB program results. Book a session now!