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.
In this comprehensive guide we will cover related topics such as Personal Finance Zero Based Budgeting, Zero based budgeting advantages and disadvantages and Zero Based Budgeting VS Traditional Budgeting.
Zero Based Budgeting Software
Tiller Money
Tiller Money links your budget to your bank accounts to transform your straightforward spreadsheet budget into a full-featured budget app! It integrates with Excel and Google Sheets, and it is the most configurable budgeting tool available.
With Tiller Money, you can budget every dollar of your income toward your objectives and expenses using their own “Foundation Template.”
Then it automatically imports all of your transactions for the remainder of the month, allowing you to keep track of your spending without having to manually enter it.
Tiller money has a FREE 30 day trial to test it out before you buy ($79/year after that).
2. YNAB
YNAB, short for You Need A Budget, is here in case you need to be instructed exactly what to do. Because, hey, you really do need one if you don’t want to spend every every penny you have and more. Perhaps you have more money than you anticipated as well.
As you may anticipate, YNAB’s main goal is to assist you in reducing your expenditure and avoiding living paycheck to paycheck. Maintain the plan and moderate your spending, and soon YNAB will realize that you are using last month’s funds rather than those you just received.
It is simple to install, supports the bulk of transaction data that can be downloaded from banks, and automatically adjusts for use by either individuals or small businesses by altering its monetary categories in accordance with your requirements.
If you stray from your course, YNAB, which is surprisingly understanding and forgiving for a piece of software, will inform you what to do to get back on track. You’ll have to make some compromises, but if direction is what you need, this stands out from competitors like Quicken.
EveryDollar
Dave Ramsey is well known for his tools and advice on setting up a budget, and he has now made a budgeting app to go along with his 7 Baby Steps.
Zero-based budgeting is favored by Dave Ramsey, and his app upholds the tenet of giving every dollar a purpose.
In fact, the exact reason his software is called EveryDollar!
His program offers both a FREE and a PAID edition, and it is quite easy to set up.
You can manually track using the FREE version, or sync your accounts (and access other features) for $129.99 per year.
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
With zero-based budgeting, you allocate 100% of your income to costs, savings, and debt repayment. By the end of the month, you want your income less your expenses to equal zero.
Every month, you can use the same spending categories and amounts, or you can vary them. The remaining money can be added to the budget for the next month or transferred to another area, such as your emergency fund, if you come in under budget in a particular category at the end of the month. It is the same idea as the envelope system, which includes putting money into envelopes for various spending categories.
ZBB in business enables top-level strategic goals to be integrated into the budgeting process by attaching them to particular organizational functional areas, where expenses may be first aggregated and then assessed against prior performance and current expectations.
Zero-based budgeting may be a rolling process completed over several years, with a few functional areas being assessed at a time by managers or group leaders, due to its detail-oriented nature. By refraining from making general increases or decreases to the budget from a prior period, zero-based budgeting can aid in cost reduction. The process is lengthy and takes significantly longer than conventional, 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
While zero-based budgeting calls for a justification of both old and new expenses, traditional budgeting calls for incremental increases over prior budgets, such as a 2% rise in spending.
While ZBB starts from scratch and requires justification of both new and old, recurring expenses, traditional budgeting simply examines new expenditures. By managing costs rather than just revenues, zero-based budgeting seeks to produce value for a company by placing the onus of justification on managers.
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 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.
Zero Based Budgeting VS Traditional Budgeting
Definition of Traditional Budgeting
Classic Budgeting is a way of planning a budget that is based on traditional cost accounting in that it allots, apportions, and absorbs overhead costs into goods.
By making modifications up or down in the previous year’s budget, the current year’s budget is created using the assistance of the previous year’s budget in order to demonstrate shifting trends for the following year. According to the rate of inflation, consumer demand, market conditions, and other factors, the expenses for the coming year are modified.
Definition of Zero-Based Budgeting
As the name implies, the budgeting technique known as “zero-based budgeting” calls for the creation and justification of each budget starting at zero. Every time the budget is made using this procedure, all the activities are reevaluated. It was developed without any consideration of the underlying prior spending plans or actual events.
In plain English, it is a budgeting technique where the cost component requires precise justification as if the budget-related tasks were being undertaken for the first time. Therefore, it is the manager’s responsibility to prove why spending money on a particular activity is necessary and to explain what would happen if the suggested activity were not carried out and no money was spent.
Key Differences Between Traditional Budgeting and Zero Base Budgeting
- Traditional Budgeting refers to the process of planning and budgeting in which previous year’s budget is taken as a base to prepare a budget. On the other hand, zero-based budgeting is a technique of budgeting, whereby, each time the budget is created, the activities are re-evaluated and thus started from scratch.
- The traditional budgeting stresses on the former expenditure level. On the contrary, zero-based budgeting concentrates on making a new economic proposal, whenever the budget is set.
- Traditional Budgeting is accounting oriented, as it works on the basic cost accounting principles. As against this, the zero-based budgeting process is decision oriented.
- In the preparation of the traditional budget, justification of the existing project is not at all required. In contrast, in zero-based budgeting, the justification of the existing and proposed project is required, taking into account the cost and benefit.
- In traditional budgeting, the decision on why a particular amount is spent on a decision unit is taken by the top management. Unlike, zero-based budgeting, the decision regarding the spending a specified sum on a decision unit, is on the managers.
- In traditional budgeting, the primary reference is made to previous spending level, followed by demand for inflation and new programmes. As opposed, in zero-based budgeting, a decision unit is split into decision packages which are comprehensive in nature and then they are prioritized on the basis of their relevance, to facilitate top management to concentrate on the decision packages only, which got preference over others.
- When it comes to clarity and responsiveness, zero-based budgeting is better than traditional budgeting.
- Traditional budgeting follows a routine approach, whereas, zero-based budgeting follows a straight-forward approach.
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.