Have you ever looked at your budget and wondered where all your money was going? Or reviewed an expense from last year and struggled to justify it? There’s a simple solution to your problems. The zero-based budgeting method. It can completely transform your finances in a matter of months.
This approach forces every department to explain why they need what they’re asking for and ensures that spending is in line with the company’s goals. It’s about putting your money where it matters most.
Read: Strategic Financial Planning – How to Plan for Success
What is Zero - Based Budgeting?
Zero-based budgeting is a budgeting method in which every expense has to be accounted for and explained from the start. In contrast to traditional budgeting, zero-based budgeting looks at every cost to see if it’s needed or not. As a result, all company departments must build their budgets from scratch and explain why each expense is necessary. Ultimately, this will ensure that the company’s money is spent wisely and that it makes sense.
It is important to mention that zero-based budgeting requires significant time and effort, as it involves a thorough review of all expenses rather than simply adjusting past budgets. While this approach improves cost efficiency and eliminates unnecessary spending, it can be very demanding and challenging to implement without the right tools.
Comparison with Traditional Budgeting
Zero-based budgeting (ZBB) takes a different approach by questioning all expenses, making sure no cost goes unjustified. Traditional budgeting, however, builds on previous numbers, often keeping past costs without questioning their necessity.
In contrast to traditional budgeting, which mostly focuses on new spending, Zero-based budgeting looks at everything new and old. This means managers must explain why each expense is necessary, preventing unnecessary budget increases.
The choice between these methods depends on a company’s goals. Traditional budgeting works well in stable environments, while ZBB is a better fit for organizations looking for strict cost control and adaptability to changing financial conditions.
The Benefits of Zero-Based Budgeting
Get Rid of Unnecessary Spending
Zero-based budgeting helps those in charge with making difficult decisions and thoroughly examining all costs, which can help cut down on spending. One way to make this process more effective is by first conducting a spend analysis, which provides data-driven insights into where costs can be optimized. Also, it enables them to concentrate on the factors that generate revenue rather than wasting resources on unnecessary expenses.
Learn how to compare what you had planned to spend or earn with what actually happened with our blog on Budget vs Actual Explained: How Does It Affect Your Business?
Strategic Resource Allocation
When managers evaluate every dollar spent, they prioritize operations that generate the highest revenue. By requiring managers to justify expenses and assess initiatives based on key drivers and insights, the most critical aspects of your product or service can be improved, ultimately improving the customer experience.
Transparency and Accountability
Zero – based budgeting promotes spending visibility, cultivating departmental accountability. This means that every department will have to take responsibility for their spendings and it will be easier to allocate the expenses rather than pointing a finger at just one person.
Adaptability
Since ZBB makes everyone re-evaluate their expenses from the very beginning, it is more suitable for changing market conditions and business changes. This allows a business to stay relevant and up-to-date with the current trends.
Challenges and Limitations of ZBB
High Resource Demands
ZBB requires teams to analyze and justify every expense from the ground up. This diligent process is far more time-consuming than traditional budgeting methods, where costs are typically carried forward and only adjusted gradually.
Resistance from Teams
Some departments may feel like the ZBB method adds unnecessary complexity to their operations. Others may oppose it since re-evaluating expenses and justifying them takes extra time. Or they could feel like it takes their autonomy and create tension with the upper management.
Short term focus
ZBB’s emphasis on eliminating unnecessary spending can sometimes lead to short-term cost reductions at the expense of long-term investments, such as research, development or employee training.
Implementation
It is important to mention that the implementation of the ZBB process starts with all levels of management.
Step 1: Educating the Levels of Management
Educating your management-level employees about the value of Zero-based budgeting will most certainly get rid of your headache in the long run. Gaining their support is crucial since implementing this method requires a cultural shift of a company.
Step 2: Set clear objectives
Having clearly set KPIs is what can make you or break you. That is why having clearly defined goals is important.
Step 3: Identify Drivers and Activities
Analyze your business processes and determine what drives revenue and growth. Focus on allocating resources to high-impact activities while eliminating unnecessary ones.
Step 4: Create a ZBB Team
Form a cross-functional team with representatives from all departments, from finance to operations.This team can oversee implementation, train colleagues, and provide ongoing support.
Step 5: Establish Budgeting Units
Divide the organization into smaller units. Each unit will be responsible for preparing its budget from scratch.
Step 6: Develop a Cost Justification System
Implement a standardized process for evaluating and approving expenses. Categorize costs depending on priority, from high, medium and low. Make sure every budget request is backed by data and aligns with strategic goals of your company.
Step 7: Re-allocate Resources and Prioritize Spending
Direct funds to high-value initiatives. Reduce unnecessary expenses and assess spending based on returns on investments.
Step 8: Implement Budgeting Tools and Technology
Use financial planning and analysis (FP&A) software to automate the ZBB process. Make sure your employees have easy access to financial data so they can make more informed decisions.
Step 9: Monitor, Review, and Adjust
Review your budget regularly to see how it’s performing. If something’s not working, reallocate funds to areas with a bigger impact.
Combining ZBB with scenario planning allows you to prepare for unexpected financial challenges while maintaining cost discipline.
Real - Life Example of ZBB Budgeting
There are numerous examples of successful ZBB implementations. Some of those are Unilever, Kraft Heinz and Diageo.
Kraft Heinz
Kraft Heinz adopted ZBB under the influence of 3G Capital, which led to substantial cost savings and operational efficiencies. Here are the steps and results:
Implementation:
- Created a culture of cost-consciousness through rigorous review processes.
- Established clear cost targets and continually benchmarked performance against these targets.
- Incorporated ZBB into their operating model which led to the identification and elimination of non-value-added costs.
Results:
- Achieved savings of $1.7 billion by the end of 2016, which funded investments in brand building and innovation.
- Improved the operating income margin from 23% in 2015 to 30% in 2016, a significant increment that showcased the power of ZBB in driving operational efficiency.
Unilever
Unilever initiated ZBB to improve brand and marketing investment productivity across the entire company, aiming to save approximately €1 billion per year by 2018.
Implementation:
- Incorporated zero-based budgeting as part of cost-reduction measures, particularly focusing on brand and marketing investments.
- Reduced overheads and eliminated waste in areas where traditional media channels were over-saturated.
Results:
- The initiative led to positive sales in emerging markets, paving the way for up to 10 years of growth.
- Despite a slight dip in net profits, the company saw a 4.1% increase in full-year sales and was on track to drive efficiencies in marketing.
Diageo
Diageo aimed to create a more disciplined culture around costs and resource allocation through ZBB.
Implementation:
- Adopted ZBB to scrutinize marketing and overhead expenses, ensuring they targeted the most value-creating opportunities.
- Engaged with stakeholders to explain the benefits and the process of ZBB, gaining their support for the new budgeting approach.
Results:
- The initiative is expected to save £500 million over three years, with the savings reinvested to drive growth.
- Created a more disciplined culture around costs, which contributed to improved business performance and shareholder value.
Conclusion
Zero-based budgeting (ZBB) is a strategic approach that ensures every expense is justified, eliminating unnecessary costs and improving financial efficiency. Instead of relying on past budgets, companies start from scratch, prioritizing spending that aligns with business goals.
ZBB requires time and effort but its benefits such as cost savings, transparency, and better resource allocation make it worthwhile. Companies like Kraft Heinz, Unilever and Diageo have successfully implemented ZBB, and achieved significant financial improvements. With the right team and structure, businesses can use ZBB to enhance their financial position and drive stable growth.
If you want to explore tools that can help you in implementing zero-based budgeting, visit Farseer’s advanced FP&A software page.
