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What is zero-based budgeting, and is it the right method for your business?

Posted by Neha De

January 3, 2022    |     5-minute read (975 words)

The concept of zero-based budgeting was developed by Pete Pyhrr in the late 1960s to early 1970s while he was an account manager at Texas Instruments. This budgeting technique has received a lot of attention over the last few years. 

Tagged as a growth enabler, zero-based budgeting originated in the consumer goods industry and has since gained traction across sectors as companies seek to maximize value and drive sustainable change. 

“Companies including General Motors Co., Guess? Inc. and Signet Jewelers Ltd. are using zero-based budgeting to slash costs and navigate the effects of the coronavirus pandemic,” read an article in The Wall Street Journal

According to Guess CFO Katie Anderson, the company had a multiyear plan to trim costs in place before the pandemic but had not previously used zero-based budgeting as part of its regular financial planning. She told the WSJ, “But when the coronavirus outbreak emerged in China in January, Guess began a weekslong, zero-based budgeting review to look at its expenses with fresh eyes.” 

The apparel-maker cut its quarterly operating costs by roughly $60 million and trimmed capital expenditures to $6 million, representing about one-third of its capital expenditures versus the prior-year interval, and it also furloughed staff and reduced some salaries, Anderson said.  
GM also relied on zero-based budgeting to cut costs as government-mandated lockdowns disrupted production, then-CFO Dhivya Suryadevara told the WSJ. The company furloughed employees and also cut spending in discretionary areas such as advertising and travel. 

So what is zero-based budgeting, and should you be adopting it for your business? 

Zero-based budgeting follows a sustainable cost philosophy as well as a bottom-up approach to rigorously reset the cost base of a business, by identifying inefficient resources and spending usage that can be freed up and better deployed elsewhere.

It exposes inefficient spending, allowing a company to reinvest in long-term sustainable growth opportunities — such as product development and innovation — by resetting its cost base and ensuring it remains lean in the long run. Zero-based budgeting also calls for cultural change that includes new processes, roles and responsibilities.

How does a zero-based budget work?

Beginning at a zero base — with no balances or expenses carried over — every period in a business’ calendar is budgeted entirely with regard to the costs and needs for that period, which can either be for a month, a quarter or a year (whatever works best for the company).

At the start of a new period, the justified expenses and financial requirements are taken as the primary inputs for the business’ budget, irrespective of whether the budget was higher or lower during the previous period. When the next period starts, you begin at zero base and repeat the process.

Should you deploy zero-based budgeting at your company?

Zero-based budgeting allows you to address what is happening in your organization at present, instead of basing decisions on past, outdated trends. However, it is not a one-time endeavor and may not work for every business. Therefore, before deciding whether zero-based budgeting is right for your business, be sure to weigh the following pros and cons.

Here are the pros of zero-based budgeting:

  • This budgeting technique works well if you are looking to cut costs, because you have total control over how much you cut. While zero-based budgeting allows you to be aggressive about cutting costs, how much you cut and where you reallocate funds is entirely up to you.
  • While historical trends come in handy when developing a budget, they do not necessarily offer a detailed look at the total spending. Zero-based budgeting requires that you examine all activities in the budget, ensuring that funds are distributed in the most efficient manner — based on current needs, instead of past trends.
  • Beginning at zero every time may sound like too much work; however, you can build a structured approach to zero-based budgeting by allowing the leadership of a company to participate in the process and provide expert insights into the activities that make up the budget.
  • This method is not just a budgeting method; it is a tool to rid your firm of all inefficiencies. By taking a look at each activity along with the decision-makers in every department, it allows you to cut out activities that are counterproductive to the success of your business.
These are the cons of zero-based budgeting:

  • Although zero-based budgeting lets you implement repeatable processes, it can sometimes be quite time-consuming.
  • Even if you can get all department heads to cooperate, they might not be able to adequately measure their needs for the entire budgeting period.
  • The budgeting process might not include fixed costs included in a contract, such as a building lease.
  • Although a particular cost may not seem important to your company’s operations, it might damage the customer’s experience.
  • For a large company, this budgeting technique might turn out to be too expensive and require too much commitment from other departments to be functional. 
How can you deploy a zero-based budget for your company?

Once you decide zero-based budgeting is the right choice for you, you can use these seven steps as a baseline for implementing the same:

Begin: Develop an annual budget from scratch without using previous year’s actuals as a baseline.

Evaluate: Assess every area of cost. Remove and minimize unnecessary activities or services.

Account for: Justify all components of the budget. Identify areas that are relevant and cost-effective, and that drive cost savings.

Streamline: Figure out which activities should be performed and how. Standardize and automate processes where possible. 

Execute: Roll out absolute planning and execution processes. Communicate uncomplicated plans, processes, roles and responsibilities. 

Examine: If any mistakes have been made, adjust and move forward with the process in the next period, or discontinue those task(s) altogether. 

Start over: Begin at the first step at the start of a new period (annual in this case).

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