Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. The process of zero-based budgeting starts from a “zero base,” and every function within an organization is analyzed for its needs and costs. The budgets are then built around what is needed for the upcoming period, regardless of whether each budget is higher or lower than the previous one.
Personal Finance Zero Based Budgeting
KEY TAKEAWAYS
- Zero-based budgeting is a technique used by companies, but this type of budgeting can be used by individuals and families.
- Budgets are created around the monetary needs for each upcoming period, like a month.
- Traditional budgeting and zero-based budgeting are two methods used to track expenditures.
- Zero-based budgeting helps managers tackle lower costs in a company.
How Zero-Based Budgeting (ZBB) Works
Zero-based budgeting is a method that has you allocate all of your money to expenses, savings and debt payments. The goal is that your income minus your expenditures equals zero by the end of the month.
You can repeat expense categories and amounts every month or mix it up. If you come in under budget in a certain category at the end of the month, add the remaining amount to next month’s budget or move it to another category, such as your emergency fund. It’s the same concept as the envelope system, which involves distributing money for different expense categories into envelopes.
In business, ZBB allows top-level strategic goals to be implemented into the budgeting process by tying them to specific functional areas of the organization, where costs can be first grouped and then measured against previous results and current expectations.
Because of its detail-oriented nature, zero-based budgeting may be a rolling process done over several years, with a few functional areas reviewed at a time by managers or group leaders. Zero-based budgeting can help lower costs by avoiding blanket increases or decreases to a prior period’s budget. It is, however, a time-consuming process that takes much longer than traditional, cost-based budgeting.
The practice also favors areas that achieve direct revenues or production, as their contributions are more easily justifiable than in departments such as client service and research and development.
Zero-based budgeting, primarily used in business, can be used by individuals and families, too.
Zero-Based Budgeting vs. Traditional Budgeting
Traditional budgeting calls for incremental increases over previous budgets, such as a 2% increase in spending, as opposed to a justification of both old and new expenses, as called for with zero-based budgeting.
Traditional budgeting also only analyzes only new expenditures, while ZBB starts from zero and calls for a justification of old, recurring expenses in addition to new expenditures. Zero-based budgeting aims to put the onus on managers to justify expenses and aims to drive value for an organization by optimizing costs and not just revenue.
Example of Zero-Based Budgeting
Suppose a construction equipment company implements a zero-based budgeting process calling for closer scrutiny of manufacturing department expenses. The company notices that the cost of certain parts used in its final products and outsourced to another manufacturer increases by 5% every year. The company can make those parts in-house using its workers. After weighing the positives and negatives of in-house manufacturing, the company finds it can make the parts more cheaply than the outside supplier.
Instead of blindly increasing the budget by a certain percentage and masking the cost increase, the company can identify a situation in which it can decide to make the part itself or buy the part from the external supplier for its end products.
Traditional budgeting may not allow cost drivers within departments to be identified. Zero-based budgeting is a more granular process that aims to identify and justify expenditures. However, zero-based budgeting is also more involved, so the costs of the process itself must be weighed against the savings it may identify.
What Is Zero-Based Budgeting?
Zero-based budgeting originated in the 1960s by former Texas Instruments account manager Peter Pyhrr.1 Unlike traditional budgeting, zero-based budgeting starts at zero, justifying each individual expense for a reporting period. Zero-based budgeting starts from scratch, analyzing each granular need of the company, instead of incremental budgeting increases found in traditional budgeting, Essentially, this allows for a strategic, top-down approach to analyze the performance of a given project.
What Are the Advantages of Zero-Based Budgeting?
As an accounting practice, zero-based budgeting offers a number of advantages including focused operations, lower costs, budget flexibility, and strategic execution. When managers think about how each dollar is spent, the highest revenue-generating operations come into greater focus. Meanwhile, lowered costs may result as zero-based budgeting may prevent the misallocation of resources that may happen over time when a budget grows incrementally.
What Are the Disadvantages of Zero-Based Budgeting?
Zero-based budgeting has a number of disadvantages. First, it is timely and resource-intensive. Because a new budget is developed each period, the time cost involved may not be worthwhile. Instead, using a modified budget template may prove more beneficial. Second, it may reward short-term perspectives in the company by allocating more resources to operations with the highest revenues. In turn, areas such as research and development, or those that have a long-term horizon, may get overlooked.
zero-based budgeting app
Tiller Money
Tiller Money turns your simple spreadsheet budget into a complete budget app by connecting your budget to your bank accounts! It works with both Google Sheets and Excel, and is the most customizable budgeting software out there.
Tiller money has their own “Foundation Template” included, and allows you to budget every dollar of your income toward your expenses and your goals.
Then it automatically brings in all your transactions throughout the month, so you can stay on track and NOT have to manually input your expenses.
Tiller money has a FREE 30 day trial to test it out before you buy ($79/year after that).
2. YNAB
Just in case you need to be told explicitly what to do, along comes YNAB – short for You Need A Budget. Because, hey, if you don’t want to spend every single penny you have and more, you absolutely do need one. And perhaps you have more money than you thought?
YNAB’s primary mission, as you might expect, is to help you curb overspending and avoid living from paycheck to paycheck. Stick to the program, temper your spending appropriately, and eventually YNAB will see you spending last month’s money rather than that which you’ve just earned.
It’s quick to install, supports the majority of transaction information downloadable from banks, and appropriately configures itself for personal or small business use by changing its monetary categories depending on your needs.
If you get off track, YNAB – which is reasonably forgiving and understanding for a bit of software – will tell you what you need to do to get back to where you need to be. You’ll have to make sacrifices, but if it’s guidance you need, this sets itself apart from the likes of Quicken.
EveryDollar
Dave Ramsey is world-famous for his budgeting tips and tools, and he finally released a budgeting app to pair with his 7 Baby Steps.
Dave Ramsey is a fan of zero-based budgeting, and his app follows the principles of giving every dollar a job
In fact, his app is called EveryDollar for that very reason!
His app is super simple to set up, and has both a FREE and a paid version.
You can manually track using the FREE version, or sync your accounts (and access other features) for $129.99 per year.
zero based budgeting advantages and disadvantages
Unlike traditional budgeting approaches, which begin with drawing up a budget or forecast for the current year (often based on the previous year’s budget) and then adjusting it based on a variety of factors such as inflation, actual spend data, updated projections, etc., the zero-based budgeting method wipes the slate clean every month and requires justification for every line item. In the zero based budgeting process, no line item is automatically transferred to the new budget from the previous month’s.
This budgeting method is forward-facing, rather than relying on historical budget data from last month, last quarter, or even last year. If traditional budgeting concerns itself with controls based on what’s being spent, zero-based budgeting concerns itself with why each expenditure is being made.
ZBB is more time-consuming and complex than traditional budgeting, but offers businesses a powerful cost reduction opportunity by reducing “budget bloat” and minimizing needless expense while prioritizing smart decision making and strategic allocation of resources. It is also extremely flexible, and can be applied to costs of all kinds: operating expenses, marketing costs, administrative expenses, cost of goods sold (COGS), etc.
Key Advantages and Disadvantages of Zero Based Budgeting
In considering whether or not to use the ZBB method, organizations need to consider the pros and cons that come along with it. It’s not a universal solution, and its capabilities may not be worth the attendant liabilities for organizations whose corporate culture, brand, or financial goals require a more traditional method of budgeting, (e.g. incremental budgeting).
Zero Based Budgeting Advantages
It’s Built on Cost-Benefit Analysis
When every line item has to be justified, it’s easier for some organizations to identify and eliminate the ones that aren’t generating adequate return on investment (ROI).
Keep in mind that this analysis can absolutely include more value-centric metrics such as total cost of ownership (TCO), social capital, and opportunities exclusive to the financial period covered by the budget, but must be contextualized inside of a larger budget in order to provide meaningful insights for these values.
In other words, zero based budgeting is monthly, but can provide data for deeper analysis in other financial models that incorporate data for the longer periods, such as the fiscal year, provided your organization makes such analyses part of its workflows.
It Prioritizes Resource Allocation Efficiency
Once a system is in place for ZBB, resources can be used with much greater efficiency because those expenses that return a healthy ROI (in profits, cost reduction, value generation, etc.) get the resources they need while less critical line items are moved down the list in priority or removed altogether rather than simply being automatically added to the next budget.
It Promotes Optimization in Business Process Management
Streamlining spend and focusing on those items that directly benefit your business through more value, cost reductions, greater efficiency, etc. helps “trim the fat” and supports continuous improvement over time. Streamlining workflows and controlling spend also helps with strategic decision-making, financial forecasting and cash flow management, and revealing opportunities to reassess priorities at the project, department, division, and corporate levels.
It Strengthens Strategic Growth and Transparency
With its emphasis on justified expenses and integration of spend with organizational goals, ZBB encourages project leaders and internal leadership alike to present clear, compelling explanations for their budgets and demonstrate how spend supports their mission and the overall growth, profitability, and competitive performance of the company as a whole.
In addition, ZBB promotes innovation and minimizes the waste and scope creep that can accompany baseline budgeting, where every dollar is often spent to protect the following year’s budget against cuts and encourage an increase—even when it’s not necessary.
Zero Based Budgeting Disadvantages
It Can Be Complex—and Expensive
Unlike traditional budgeting approaches, zero based budgeting can be very costly, as well as time-consuming and complicated, to implement. The extra training required (including using any new software, workflows, etc.), along with the fact that each budget is built from scratch rather than relying on the (quicker and easier) data from last year can add significant expense when making the change. For companies operating on thin budgets, the strain may prove prohibitive.
Time constraints, too, may be an issue, with financial teams working overtime (both figuratively and literally) to coordinate across business units to ensure all budgets are updated, accurate, and complete across the entire budgeting process.
It’s Linked to Tangibility
For departments whose deliverables aren’t quite as cut-and-dried as, say, procurement (where the procure-to-pay (P2P) process offers multifold opportunities to adjust workflows and spend for savings and value), prioritizing spend and, by extension, justifying it to stakeholders higher in the financial food chain can quickly become very challenging indeed.
It’s Disruptive
Making the change to ZBB can prove emotionally and intellectually taxing for some. Managers may find it difficult to make the switch to prioritizing and justifying every item in their budgets on a monthly basis, creating pushback that needs to be addressed before you can operate at peak efficiency.
A significant change to your budget process can also threaten to disrupt operations through potential changes driven by strategic decisions to change suppliers, or create additional risk exposure if you don’t have sufficient data to forecast measurable savings, value, or productivity improvements.
One area of disruption that might surprise you is the potential impact on your brand and reputation. Major changes in internal processes can have unintended impact on customer experience, particularly if cost-cutting (for example) leads to changes in materials or pricing that alter customer perception. In addition, shifting to a cost-benefit analysis model can make it difficult to provide “soft” value customers associate with a premium experience and brand, or make it harder to price goods and services at a premium (a major issue if your brand and reputation are built around such concepts).
Make a Smoother Leap to ZZB with Analytics and Automation
Rather than taking an “all or nothing” approach to zero based budgeting, many companies are finding success in applying it incrementally, where its context-sensitive and short-term benefits can make optimal use of data-driven insights to achieve cost reductions and create value.
One of the most reliable ways to make such an implementation a reality is by choosing to centralise data and spend management with a comprehensive, cloud-based solution like PLANERGY.
Why? Intuitive tools for collecting, organizing, and analyzing all your spend data make it much easier to develop workflows and controls you can use to create accurate, transparent, and complete forecasts, budgets, and financial reports. Total spend transparency, guided buying, and robust modules for contract management, supply chain optimization, and strategic planning help you take advantage of opportunities in the short-term while simultaneously managing your long-term goals for growth, innovation, and competitive performance.
Automated workflows simplify repetitive, high-volume tasks and provide the data you need to spot opportunities to cut costs, improve efficiency, or create value. Plus, with fewer tedious, time-consuming, and low-level tasks on their plate, your financial team can dedicate their skills to strategic decision making and more proactive budget management through ZBB.
Best of all, investing in a software solution can help you avoid the potential disadvantages of implementing a zero based budgeting solution by reducing the time needed to bring your team up to speed, lowering the costs of restructuring your budgetary processes, and providing demonstrable value that can help set the stage for a larger, long-term digital transformation strategy.
Is Zero Based Budgeting the Right Fit for Your Business?
Private or public, large or small, every business has different budgetary needs. And if your company or organization is looking to make a shift toward ROI-focused, efficiency-minded budgeting techniques while still maintaining the flexibility to leverage opportunities and handle unexpected disruptions, incorporating zero based budgeting can help.
With the right tools and a commitment to securing buy-in from key stakeholders, ZBB can help you build results-oriented budgets that help you cut waste and bring your entire team on board to make smart, strategic spending decisions in the short-term budget cycle that benefit your company in the long term throughout proactive, intelligent financial management.
Conclusion
A budget is an important tool for anyone, regardless of their income. It can help you organize your life and save money, both of which are essential in order to improve your quality of life. Additionally, creating a better budget can help you evaluate your spending and create more effective budgets that will save you even more money in the long run.