What is zero-based budgeting?

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What is zero-based budgeting? 

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Zero-based budgeting (ZBB) helps you take control of your company's spending by starting each budget period from zero. Instead of carrying over last year's budget, you evaluate and justify every expense based on current needs and business goals. This is typically done by department leads to provide the accounting team with more granular numbers. This type of budgeting method ensures that all expenditures are accounted for based on current needs rather than relying on assumptions from the previous year’s budget.

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Companies use zero-based budgeting when outflows need to be carefully monitored. That could be in cases where funding is limited, costs need to be weighed carefully, or simply to get spending under control. The technique is not as popular as it once was because pricing and cost structures tend to vary in-period, but it’s still highly effective as a type of budgeting method.

How zero-based budgeting works

Zero-based budgeting is primarily a technique to help you better manage business cash flow. According to a global cost management survey conducted by Deloitte, 43% of global companies surveyed reported hitting their cost targets when using ZBB. Businesses that failed to meet their target costs attributed it to over-aggressive pursuit of cost targets and rising inflation.

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Success with zero-based budgeting is achieved by carefully monitoring costs throughout the period and strategically managing this cash flow. The system is designed for department heads and executives to give them real-time insights into their spending without the burden of past period estimates and future projections. In short, it’s a budgeting process that works in the present tense and provides cost savings.

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Let’s use a marketing department as an example. By budgeting specific amounts for social media spend, advertising design, and search engine marketing, the department is limited in how much they can allocate to their marketing campaigns. This keeps overall costs down and facilitates better financial planning and analysis, which can be used for the next period’s budget. Additionally, using a budget template can help organize and streamline this allocation process.

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A simpler analogy for this is that your department is given a certain amount of cash to spend and no credit card to go over budget. At least, that’s how it works under perfect conditions. Unfortunately, costs are sometimes higher than projected, and market conditions can change. Those are two of the factors that can cause challenges with a zero-based budget.

Zero-based budgeting versus traditional budgeting

Traditional budgets are constructed by reviewing the total amount spent in the previous period and setting the new budget as a percentage increase or decrease from that number. The flaw in this method is that spending is not analyzed and restructured to eliminate waste. Several established companies have traditional budgets that are over-inflated. Some of the areas where that waste occurs include:

• Spending money on excess inventory
• Using outdated office equipment
• Double spend on SaaS subscriptions or lack of SaaS management
• Unnecessary outsourcing
• Energy inefficiencies
• Office supplies

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Zero-based budgeting is more of a real-time expense tracking system. Since the numbers are only compiled for the present period, there’s no chance of carrying over wasteful costs and expenses that are no longer relevant. Those can be detected and eliminated if any of them appear during the period you’re operating a zero-based budget.

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The key to making all this work is careful monitoring by department heads and accounts payable coordinators. One-time expenses can be checked off as they happen. Categorized business expenses that are tracked monthly can be monitored with periodic milestones. Both actions require an accounting system that does real-time expense tracking and can streamline the allocation process.

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For a company to be effective with zero-based budgeting, everyone must be on board. Supervisors and teams need to work cross-collaboratively while being fully responsible for their individual department budgets. Without this level of cooperation, zero-based budgeting can quickly fall apart. This bottom-up approach ensures that expenditures are thoroughly evaluated at the department level.

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If you’re transitioning from traditional budgeting to zero-based budgeting, it’s a good time to evaluate expenses where you automate bill payments. Companies that have been around for a while typically have automated expenses that may no longer be valid. Look for software subscriptions, marketing fees, and utility bills for defunct locations. Additionally, consider implementing forecasting tools to anticipate upcoming expenditures.

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Pros and cons of zero-based budgeting

Zero-based budgeting may not be appropriate for all businesses. Implementing it requires a cooperative effort between accounting teams and administrators, so communication and transparency are critical for success. Here are some advantages of zero-based budgeting to consider when deciding whether the use of ZBB is right for you:

• Focused operations: Implementing zero-based budgeting allows your department heads to focus on only their costs and expenses, eliminating the need to worry about the company’s overall bottom line.
• Lower costs: You can reduce cash outflows by limiting costs to only those included in the zero-based budget. This reflects well on your quarterly balance sheet.
• Budget flexibility: Zero-based budgets are not tied to previous period budgets, so there’s more flexibility in developing them.
• Strategic execution: Constructing individual zero-based budgets for each department gives you the freedom to make more strategic business decisions.

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Though a zero-based budget may be simpler for department heads to understand, it’s more complicated for companies to develop, especially if you’re coming out of a period where you used a traditional budget process. Some other disadvantages to consider are:

• Resource intensive: Zero-based budgets need to be created from scratch each period. This makes them extremely resource-intensive and time-consuming, requiring a heavy lift upfront.
• Short-term perspectives: Zero-based budgeting gives you a good short-term perspective on spending for that period. However, it does not account for the next or last periods.
• Long-term horizons are overlooked: Since perspective is short-term, long-term horizons for departments like R&D are often overlooked.

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Many companies switch to zero-based budgeting for a short period while trying to control costs, then transition back to a more traditional budget method. Unlike your accounting system, you’re not “locked in” to do this for the life of the company.

When to implement zero-based budgeting?

This is a question of circumstances and needs. If your company has the internal discipline and resources to implement a zero-based budget, you can and should consider it. Once that requirement has been met, ask whether it’s the right choice for you. This is the needs portion. Do you need to get costs under control? Do you need better insights into your spending?

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Keep in mind that this does not have to be a permanent change. Zero-based budgeting can be set up as a short-term project to streamline your spending. It’s also a good fit for new department heads who need to be vetted before giving them a more traditional budget and the power to modify spending when needed.

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Outline your objectives before devoting the resources to implement zero-based budgeting. You’ll be committing to at least several periods where budgets need to be constructed from zero. That takes personnel and time. Does your company have the bandwidth to pull that off? This is an important question you need to answer before you begin.

Best practices for implementing zero-based budgeting

The success or failure of zero-based budgeting depends entirely on your company's structure and communication abilities. Objectives must be clearly outlined, and the timeframe for the project should be decided before you begin. To ensure your success, we recommend the following best practices for implementing your new zero-based budget system:

• Install automated expense tracking software: Determining success or failure with zero-based budgeting is dependent upon the tools you use to track results. Expense automation and tracking software will show you exactly what your costs are and help with performance management.
• Define roles and responsibilities: Organize a series of meetings with key personnel who will manage the new budget. Define roles and responsibilities and make sure everyone is on the same page. Ensure lines of communication are open and employees are empowered to make the right decisions.
• Set goals and milestones: What is your objective in implementing zero-based budgeting? It’s important for you to know and communicate that with others at your company—set goals for the end of the period and milestones to track during it.
• Schedule frequent reviews: No system is perfect on its first iteration. Schedule frequent reviews to track your progress and discuss modifications when necessary. The system will remain the same, but some of the numbers are likely to change. Frequent reviews align with a robust review process to ensure better cost management.
• Don’t give up too soon: Deciding after one iteration that zero-based budgeting doesn’t work is a mistake. Give it enough time to fully evaluate the results. Internal resistance and early-stage mistakes are common. Get past those before passing or failing ZBB.

Get full transparency into expenses with Ramp

One common stumbling block with zero-based budgeting is allowing employees to submit manual expense reports. With Ramp, expenses can be automated and controlled. Limits can be set on spending, and certain expenses can be allowed or disallowed. Your company will need a system like this to be effective with zero-based budgeting.

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Another advantage to using Ramp is the hundreds of integrations we have with other software systems, including budgeting software and accounting platforms. Our transparency into expenses makes it simpler to create financial reports each quarter, giving you another metric to measure the success of your zero-based budgeting implementation.