What Is Zero-Based Budgeting? Pros and Cons and How to Start
Imagine you’re an Olympic gymnast, and you’ve trained most of your life to qualify for the Olympic games. Then, the second you step up to the balance beam to enter what could be the most important competition of your life, you put on a blindfold.
It seems crazy (and a little dramatic), but that’s kind of what happens with small businesses that put a lot of effort into driving sales and keeping sound financial records but don’t take advantage of zero-based budgeting.
Without zero-based budgeting, companies may be blindly scaling budgets without taking a close look at their past records and where their money is going. They are essentially taking a gamble on their financial future.
Do you practice zero-based budgeting?
Let’s take a closer look at what it is and why it is important. After reading, you can make a decision as to whether you should use it for your business…
What Is Zero-Based Budgeting?
Zero-based budgeting is a method of budgeting that pretty much functions like its name suggests—you start your budgets from a zero base. So, at the beginning of each year, you wipe out your budgets from years prior and start from scratch.
What does this mean exactly?
When building budgets on the zero-based system, you won’t be using last year’s budget to inform this year’s. You start from a “zero base” and then analyze your past costs and your needs for the upcoming quarters.
With zero-based budgeting, you make decisions based on real-life data instead of guesswork, and justify every past and future expense. In addition, your business may have evolved considerably over the year (along with your industry), and this requires a deeper look into what is and isn’t working.
According to McKinsey partner Wigbert Böhm, zero-based budgeting typically involves the following stages:
- Creating an environment of transparency using data and digital tools to analyze business-wide spending according to cost center, category. and sometimes vendor. According to Böhm, “Through this exercise, budget owners for the business units often find that quite a bit of company spending, about 15 percent or 20 percent, is misclassified.”
- From the data, identify operational and process improvements and adjust spending to reflect these new insights. During this stage, leaders must reflect on objectives and benchmarks.
- Gather all of the data from the above and, starting from zero, create a budget.
- Measure outcomes to ensure that zero-based budgeting initiatives are adhered to throughout the organization.
Does zero-based budgeting actually work?
In a recent interview, Wigbert Böhm stated that a large European utility found savings of $150 million from its baseline spending of $900 million as a result of using zero-based budgeting. Combing through the data, executives found duplicate spending and opportunities to reorganize its workforce to increase efficiency.
By looking at your data and implementing zero-based budgeting, you can discover misclassified spending, improve operational efficiency, and stay accountable to your company objectives.
The bottom line? YOU are in control of your company’s finances.
Why Zero-Based Budgeting Is a Game-Changer
The reason why zero-based budgeting can be a game-changer for businesses is because it removes ALL assumptions about past performance and forces you to look at the DATA.
If you know anything about us here at Viral Solutions, we are data hogs. When you work with us, we never make assumptions about what will and won’t work for your business. If we did, we would be gambling with your money. We don’t think you should be gambling with your money either.
Zero-based budgeting also holds businesses accountable. Your future investments should be calculated after reviewing your past data and the KPIs you set from your company objectives. By creating new yearly objectives and KPIs, you are holding team members accountable for reaching those KPIs.
This type of accountability forces managers to answer questions such as the following:
- Can we still afford shelling out this much money into a particular marketing tactic?
- Does XYZ practice still require just as many resources this year as it did in year 1?
- Are there better methods, contractors, and/or resources that could help us hit our objectives so we can spend less than previous years? (Zero-based budgeting requires managers to prove that the same quantity of resources are required to achieve the same business objectives.)
Marketing expert Mark Ritson says this about zero–based budgeting: “In reality, what happens is that senior managers bet their resources on the better marketers with the better plans and the better opportunities and reduce investment in the crappy marketers with crappy plans. The strategic approach, in other words. If you get your requested investment you then have to provide the promised financial return at the end of the year or your ass will be delivered on a tray. Accountability I believe it’s called.”
Zero-Based Budgeting Example
Here’s what zero-based budgeting may look like. Consider this simplified, but typical scenario:
A company that manufactures and sells cameras implements a zero-based budget. They spent 1 million on manufacturing last year and want to increase the budget to amp up inventory. Using a zero-based budget forces them to scrutinize every manufacturing expense and justify the costs associated with each.
During a review of their manufacturing expenses, they discovered that they were spending more than they should on camera parts. By switching manufacturers, they saved 3% on costs. Had they blindly raised the budget based on last year’s numbers instead of looking at the budget line by line, they would have spent more than they needed to.
Did the zero-based budgeting process take time to execute? It sure did. Was it worth the thousands of dollars they just saved? You bet it was.
Zero-based budgeting is also KEY for creating a bulletproof marketing strategy. Imagine if this same company noticed that one of the marketing tactics they were funneling a lot of money into lost momentum toward the end of the prior year. If they had blindly increased the marketing budget to fuel these faulty tactics, they would continue to funnel money into dead practices.
Cons of Zero-Based Budgeting
So we’ve talked a lot about why zero-based budgeting is a good move for your organization. But, like anything else, it does have its cons…
Zero-based budgeting requires time and resources to execute correctly. And the results are not guaranteed since your success depends on what you put into it. This is why many businesses don’t fully embrace it. This was more of a problem before digital tools came on the scene, however. With the right software, zero-based budgeting isn’t as daunting as it once was. But, it still requires manpower and resources.
Zero-based budgeting also requires consistent dedication. It isn’t something you “try” to see if it works. You’re either dedicated to fully embracing it or not. If you aren’t fully dedicated to investing the time and resources to get it done right, it won’t produce results.
Zero-based budgeting is a MIND-SET. It focuses on staying accountable to every dollar spent and doesn’t allow unnecessary expenses to creep their way through the budget. (Company retreats to Bali, anyone?)
Phil Rumbol, founding partner at agency 101 London, as reported by Marketing Week, says he spent “an inordinate amount of time” on the phone talking people through spreadsheets. “All the while, I wasn’t actually thinking about how I could grow the business. I’m sure there’s a good way of doing it but when done badly, it creates a whole lot of bureaucracy.”
Zero-based budgeting also requires a level of expertise to do effectively. Without the right people leading the effort, it’s easy to get lost in spreadsheets and data sets, which leads to premature abandonment.
Is Zero-Based Budgeting Right for You?
It depends. Just because this style of budgeting seems right, it’s important to remember that it can be laborious to do a line-by-line analysis of where every dollar is going. For small businesses, this may be easier. But, as you grow, spending 3-4+ days on the budget every year may steal resources. You need to weigh the cost vs. the potential savings.
It may be something you do every other year at a minimum, or when a new leader steps in. But, take it seriously because zero-based budgeting can save you money and keep your business on top of its spending, which helps you thrive in the long term.
Now, if you have a tight grip on your accounting and you know exactly what goes in and comes out and are constantly reevaluating your KPIs and where you can save, you may not need to do a zero-based budget every year. But, we find that the majority of businesses don’t operate like this. They are focused more on the cooler metrics such as sales and revenue instead of looking at budget analysis.
Zero-Based Budgeting – What You Need to Know
In this post, we looked at how zero-based budgeting can help you get a tighter grip on your expenses and costs so you can take more control over your finances and budgets. This leads to greater operational efficiency and stimulates business growth.
Though this type of budgeting is ideal, it requires manpower and expertise, along with the right mind-set that values data above all. Your mind-set must be focused on looking at all necessary data, starting from complete zero, and leaving no stone unturned.
If you take anything from this article, let it be this: Your data is speaking to you—LOUDLY. If you aren’t listening, you will cripple your business from growing. This applies to budgeting, marketing, and everything in between.
If you’d like to have a conversation about how we can help you become a more data-driven organization to fuel your long-term growth, get in contact with us here.