Some companies avoid zero-base budgeting (ZBB) because of misconceptions about it meaning that you have to start from scratch. However, it can actually be an effective way of encouraging a positive cost management culture. This allows organizations to better manage their finances, while also changing behaviors of management and employees.
What is ZBB?
A ZBB system assumes that managers have an expenditure base line of zero, by demanding that managers explain all of their spending rather than only having to justify any changes that occur from one month - or one quarter - to the next.
This isn't as intrusive or labor-intensive as some may assume, as most companies using a ZBB allocate managers a core budget for basic departmental operations. Anything above this threshold will need to be justified. In this way, a ZBB aims to constantly ensure a company's expenditure is aligning with the organization's goals and quickly eradicate any efforts that don't feed into or support these main objectives.
It's fairly self-explanatory therefore that the first step under a ZBB system is always to identify what the business's core objectives are before looking at methods and funding options for achieving these goals.
Companies will then often outline priorities for the business, based on its objectives, methods and funding identified in the previous stages.
What are the advantages?
There are many advantages to ZBB, mainly focused around the business objective-focused approach and non-biased allocation of resources. Some of the most common advantages are:
- Greater transparency - Managers have to be clear and transparent with the finance department and Directors about where they are spending their money. ZBB makes it much more difficult to artificially inflate budgets, for instance.
- Innovative thinking - As managers must look at alternative methods of achieving objectives, such as training professionals in-house or outsourcing, it encourages them to be more creative and innovative in their thinking.
- Prioritization of company objectives - ZBB naturally encourages managers to constantly think about how their methods relate to business objectives.
- Eliminate non-key activities - The constant reviewing of budgets forces managers to identify activities that aren't essential to the company.
What are the disadvantages?
The biggest disadvantage of zero-base budgeting is the level of effort needed to constantly evaluate activities and justify which ones are valuable to the company.
- Increase of admin - Creating a ZBB system requires a lot of effort from managers, Finance and directors, especially at the start.
- Intangible justifications - Not all elements of a business make a tangible return on investment (ROI), such as efforts to boost employee retention or morale. ZBB can make it difficult to prove the value of these projects.
- Additional training - Managers will need to be trained in the zero-base budgeting process, on top of the time required to actually evaluate and analyze their budgets under the new system.
- Discourages budget revision - With extra effort required to create a ZBB, managers may be less likely to revise their budget regularly, potentially jeopardizing the company's competitive edge.
Moving your organization to a ZBB system
If you decide moving to a ZBB system will benefit your company, there are a number of steps you should take to ensure everyone, especially managers, are prepared for the shift.
Identify business objectives
You need to identify the core objectives driving your business. These should be tied into your growth strategy and any expansion plans you may have. It's important to make sure they are realistic and have measurable goals and KPIs to allow you to track your progress. Use previous fiscal data and customer insight to guide you and don't hesitate to discuss your ideas with directors or finance specialists.
Evaluate the basic cost of running a department
To give your managers a workable zero baseline level of expenditure, you need to determine what the basic costs of running a department are. Liaise with management teams and find out what their main expenses are, what they think could be reduced and what they believe will increase over time. They are a valuable resource in understanding the running costs of departments and the switch to ZBB will affect them more than most, so it's a good idea to get them on side from the start.
You then need to identify who will need training to be able to execute ZBB properly. Of course, you'll need to upskill managers so they can accurately deliver their budgets and justify additional spending but do your directors need training too, and what about the finance team? Everyone needs to feel prepared and equipped for the change if it's going to work.
Liaise with departments
Discussions about how ZBB will impact your financial forecasts in the long and short term are things decision-makers in the company need to be aware of from the start. Talk with other departments about the changes and make it clear that you value their input.
Don't go alone
You should form a cross-functional project team with professionals from IT, finance and management. This will preferably be led by a decision-maker who has a strong understanding of the business objectives and the best way to achieve them. ZBB relies on analysis and review so you need as close to a cross section of your company as you can. This will help you to identify what are vital and unnecessary activities. Each representative will be able to tell you about their own department, but you need a non-biased decision-maker to put the business at the heart of every compromise made.