The Ups and Downs of Zero Based-Budgeting
Updated: Nov 16, 2022
Zero-based budgeting (ZBB) is quickly gaining traction as organizations around the world seek innovative ways to operate more efficiently, enhance revenues, and increase agility. A zero-based budget, in contrast to traditional activity-based budgeting, cost-based budgeting, and top-down budgeting, examines and justifies each and every expense. Both regular and new expenses that may arise during the budgeting period are factored into the process. Every expense is examined, justified, and, if necessary, eliminated.
The concept of a zero-based budget is founded on the principle that every dollar of revenue must be spent on something. Every one of those "somethings" must be justified. As a result, a zero-based budget must be created with a specific aim in mind, or every dollar of revenue will be misallocated.
Although ZBB marks a significant shift in the way finance teams generate budgets, it has some specific advantages, particularly for organizations seeking greater agility and efficiency gains. This post reviews the advantages of Zero Based Budgeting as well as some of the disadvantages of ZBB when compared to traditional budgeting methods.
Putting the Focus on Needs
The obvious advantage of zero-based budgeting for most people is that it allows you to eliminate all of an organization's budgetary "clutter" in one swoop. The zero-based approach necessitates that budget owners justify all expenditures.
In this regard, ZBB is a good tool for identifying and eliminating unnecessary line items that have accumulated over time. It assists business leaders in streamlining inflated budgets and bringing costs under control while minimizing any detrimental impact on operations. In fact, ZBB frequently leads to new innovations that help the organization run more smoothly.
Because ZBB compels managers to examine and assess each line of their budget, resource allocation is based on current needs rather than historical tendencies. During that process, it's not uncommon to come across "legacy" expenses that aren't adding any value to the company but have persisted in large part due to organizational inertia.
ZBB practices would encourage a corporation that pays annual dues to a professional association or has a long-term advertising agreement with a trade publication to review such expenses and assess how much value they generate in comparison to other budget line items. ZBB requires businesses to prioritize and adopt a more deliberate approach to costs, focusing on the areas that provide the highest value to the company.
As a result, ZBB enables organizations to decrease expenses more aggressively because it is a very deliberate process. There are no “across-the-board” budget cuts under the ZBB paradigm.
Zero-based budgeting also encourages managers to find new ways of improving efficiency, innovate, and decrease costs without affecting their departments or lines of business. Businesses that use outdated technology, for example, may find that by replacing or upgrading their current systems to more modern ones, they may achieve more with less. In the process, they generally gain significant additional value in the form of improved, more sophisticated capabilities and greater insights that enable better business decisions.
Similarly, many organizations will learn, after implementing ZBB, that internal tasks or business processes could be performed more effectively and efficiently by an outside firm. Because ZBB requires organizations to evaluate and justify each line item in their budgets, it drives and incentivizes managers to look for cost-cutting opportunities.
Improving Communication and Collaboration
Zero-based budgeting requires a substantial shift in how people approach budgeting. In reality, one main disadvantage of ZBB is that it can be time-consuming, especially the first time a company creates a zero-based budget. Although that is a downfall, ZBB tends to necessitate improved communication and collaboration among department heads or line-of-business leaders.
Because each line item necessitates a higher level of evaluation, and because ZBB encourages managers to think creatively, the process invariably leads to broader and more in-depth discussions throughout the organization. People begin to raise major questions about priorities. ZBB sparks discussions about how the company may improve its processes and increase its efficiency. Much of the additional "work" necessary for ZBB is actually vital communication that has never occurred before because traditional budgeting systems did not necessitate it.
The Downside to Zero-Based Budgeting
So, what are the disadvantages of a zero-based budget? ZBB can feel like a lot of work at first, especially when you're first implementing it. This could potentially be a cause of opposition from stakeholders. After all, in most organizations, resistance to change is a typical occurrence. ZBB requires active buy-in from all levels of management. However, with the correct tools, the process may run smoothly, resulting in better, leaner budgets.
There are a few more downsides to ZBB. Some critics argue that ZBB tends to promote short-term thinking by encouraging managers to shift their attention (and budget allocations) to activities that generate quick revenue rather than thinking long term.
Another prevalent criticism is that ZBB may be inconvenient for departments with difficult-to-measure production. Public relations, for example, can be a crucial function, and while overall reach and sentiment are simpler to quantify now than in the past, putting a cash amount on the value created by a successful PR staff can still be difficult.
Finally, others argue that ZBB is easily influenced by management who choose to "overpromise and under-deliver." In other words, they plan a budget around projected future benefits, but they don't always follow through on their promises. Of course, the solution to this challenge is to establish unambiguous accountability, which involves evaluating and tracking results against those initial targets and holding employees throughout the organization accountable for their promises.
Making the Process Manageable
Although zero-based planning requires more effort than standard budgeting, for most businesses, the benefits exceed the expenses. Many organizations opt to roll out ZBB in stages, beginning with one department or business unit, to reduce risks and problems. Investing in software that lets managers work around a systematic strategy and allows for broad participation from stakeholders is strongly recommended, regardless of how you start the process.