What is zero-based budgeting (ZBB)?
Zero-based budgeting (ZBB) is a methodology that helps align company spending with strategic goals. Its approach requires organizations to build their annual budget from zero each year to help verify that all components of the annual budget are cost-effective, relevant, and drive improved savings.
Implemented effectively, ZBB is a cost discipline that can help businesses improve resource planning, employee engagement, and organizational collaboration. Although ZBB is often credited with measures to reduce costs, its approach doesn’t exclusively focus on savings and can help test assumptions, solve problems, and ensure that spending is aligned to the growth objectives of the organization. If performance does not meet expectations, ZBB can help businesses identify how to best course-correct for the months ahead.
Done right, ZBB can translate into cost savings that fund future strategic initiatives and drive growth.
How zero-based budgeting is different from traditional budgeting
The ZBB methodology operates in stark contrast to traditional annual budgeting approaches. Traditional annual budgets are often produced by taking the previous year’s actuals and adding a few percentage points to account for wage rises and inflation. This simplified and incremental budgeting can lead to inefficiencies and missed opportunities for greater cost savings.
ZBB requires that organizations build their annual budget from zero each year (thus its name) to help verify that all components of the annual budget are cost-effective, relevant, and that they drive improved savings.
Here is a brief outline of the principles of both traditional cost-cutting and a zero-based approaches.
|Traditional cost cutting approach||Zero-based budgeting approach|
|Justify what to remove||Justify what to keep|
|Focus scope on a narrower set of costs or cost reduction tools||Examine every cost area for the broadest set of cost reduction tools|
|Improve how activities should be performed (efficiency and effectiveness)||Consider which activities should be performed (i.e., doing less) and how they should be performed|
|Create focused initiative planning and execution||Develop detailed and comprehensive initiative design, planning, and execution|
The advantages of zero based budgeting
In recent years and amid increased uncertainty, businesses have looked for additional ways to improve growth and cut costs. This has led many organizations to re-examine zero-based budgeting, an approach to budgeting that has been around since the late 1970s.
Traditional budgeting approaches begin with the previous year’s budget and look for areas to tweak; they don’t necessarily take the time or ownership for thoughtful reflection on the impact of those expenditures.
With ZBB, managers are challenged to identify the most cost-effective way to deliver their activities, programs, and levels of service, while keeping their resources in step with changing workloads and eliminating extraneous expenses that are not aligned with strategy.
Why were approaches to ZBB difficult to achieve in the past? Previous attempts to execute ZBB approaches had been simply too complex for spreadsheets and manual planning environments. Legacy planning systems added further complications with architectures that grappled to provide the flexibility needed to amend models.
Advancements in planning technology have enabled businesses to re-evaluate the opportunity of ZBB and successfully implement within the organization. By leveraging modelling platforms that aren’t limited to specific or expected financial line items, businesses can model any process required for their planning needs, and implement ZBB quickly and effectively for fast, agile, and dynamic budgeting cycles.
Companies that have adopted ZBB report cost savings between 10 and 25 percent—vital savings that companies can use to bolster their margins or invest in future growth. Unlike top-down across-the-board cost-cutting initiatives that can compromise service levels and damage revenue, ZBB focuses on doing the right things in the most cost-effective way. It can provide a low-risk approach to transforming the cost base while leaving companies adequately resourced and well-financed for future growth.
The 5 steps of zero-based budgeting
Businesses can develop or modify their own unique approaches to ZBB, and the following five steps can provide a baseline for implementation.
- Start. Begin at ground zero. Create a new annual budget from scratch without using last year’s actuals as a baseline.
- Evaluate. Evaluate every cost area. Eliminate and reduce unnecessary activities or services.
- Justify. Account for all components of the budget. Identify areas that are cost-effective, relevant, and that drive cost savings.
- Streamline. Determine what activities should be performed and how. Automate and standardize processes where possible.
- Execute. Roll out comprehensive planning and execution processes. Communicate clear plans, roles and responsibilities.
The fundamentals of ZBB according to Deloitte
According to Deloitte, a successful ZBB approach adheres to the following fundamentals.
- Budgets are not connected to the prior year’s spending
- Prevents “embedding” of existing spending in the cost base
- Allows spending levels to be set based on the necessary activities of a function, rather than historical trends
- Requires more work than legacy programs to understand activities and cost structure
- Cuts are applied across the budget
- Eliminates common “sandbagging” practices in the budgeting process
- Allows for more strategic allocation of planned spending
- Requires more work than legacy programs to analyse and prioritize
- Budgets are tied to specific activities and levels of service
- Better aligns spending targets with the required activities of a function
- Replaces “do more with less” with “do the right things with the right amount”
- Requires detailed knowledge of departmental activities
- Funding is targeted to activities that align with the corporate strategy
- Allows better alignment of expenditures with the overall strategy and departmental missions
- Can reduce incidence of “we’ve always done that”
- Prioritizing activities across various functions can be challenging
5 zero-based budgeting best practices
- Adopt a positive approach. ZBB is more than just slashing 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 indirect costs that are not clearly understood. Not only will such choices 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.
- Don’t do it alone. Assemble a cross-functional project team with members from finance, IT, and other relevant business units, and preferably chaired by a C-level executive. The core of ZBB is the challenge and review process—scrutinizing every activity that a department undertakes to see if it can be stopped or done more cheaply. It may be worthwhile to pay an experienced and objective third party to help negotiate the inevitable compromises.
- 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. Manipulating this data in ancillary spreadsheets increases both the complexity and workload involved in any ZBB initiative. A better alternative is to hold all the detailed operational and financial data on a single financial planning and analysis platform, such as IBM. Such a platform makes it easy to model the causal relationship between activity volumes and the resulting resource requirements. In addition, IBM’s proprietary in-memory calculation engine provides the necessary power to process the large volumes of data involved.
- Plan for sustainability. Once you have implemented a successful ZBB project, keep your skills fresh by moving on to other business units or expense categories and revisiting previous projects to ensure that the savings stick. Don’t mothball your ZBB model either. Because it contains the causal relationships between various activities, the resulting resource needs, and the 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 FP&A processes. Successful ZBB projects should result in a heightened awareness of cost control. Keep in mind that the awareness won’t happen if the organization returns to the traditional incremental approach for annual planning and budgeting once the implementation is over.
How to get started with zero based budgeting implementation
- Integrate ZBB with core FP&A. ZBB should not be seen as an alternative to current planning and budgeting cycles, but as an auxiliary process carried out every couple of years to refocus spending on strategically important activities and initiatives.
- Focus ZBB initiatives for maximum returns. Many companies limit their ZBB initiatives to SG&A and other areas of overhead, where there are large amounts of indirect costs that are less well understood. This allows targeting specific parts of the organization and gaining major benefits for a limited investment without overly disrupting customer-facing business functions. Others choose to limit their use of ZBB to new business initiatives and requests for additional funding while using other methods of budgeting for ongoing activities.
- Unify operational and financial data on a single platform. The success of ZBB depends on managers having both a deep understanding and visibility of the operational drivers of costs. Providing such visibility means having granular details of cost (right down to an individual employee, a business trip, or a marketing campaign) and easy access to data around activity volumes, productivity, and resource consumption.
- Make modelling easy. The ability to model the causal relationship between activity volumes and the resulting resource and headcount requirements is critically important because managers need to make informed decisions about how changing activity volumes and different service levels impact costs.
- Re-use ZBB models for routine FP&A process. If an organization uses an incremental approach to planning and budgeting based on the previous year’s actuals, the ZBB model will be the first enterprise-wide model of causal relationships that link activities of different business functions. FP&A teams should adapt the model as needed to support the annual budgeting process and rolling re-forecasts, which will become more efficient and deliver greater insight. Repurposing models in this way means ZBB is no longer a standalone exercise, but an initial step in transforming enterprise planning and budgeting that could lead to fully integrated business planning.
Benefits of an Effective ZBB strategy
Organizations that use an effective approach to ZBB report a multitude of benefits. In addition to increased cost savings, here are six benefits that ZBB can provide:
- Improved business margins through cost savings and alignment of spending to strategic objectives
- A cost discipline that’s created and focused on operational execution to support business growth
- Forward-looking resource plans that align to the projected future business state
- Enhanced staff engagement in budgeting for impact and thinking about what “moves the needle”
- Increased manager accountability for spending and that embeds a continuous culture of cost awareness
- Conversation and collaboration among all managers and planners to work together toward a common goal of expense budgeting focused on meeting the needs of the business
For ZBB to be successful, it needs to be modelled and delivered through a capable and flexible planning solution. IBM Planning Analytics, a cloud-native solution, can enable, support, and execute effective ZBB methodologies even in today’s increasingly volatile business environments.
- Zero Based Budgeting Evolution: from ZBB to Zero Based FP&A
- ZBB as a Management System and Culture – Customer Stories
- ZBB Technology Enablers
- Conclusions and Recommendations