What is zero-based budgeting?
Zero-based budgeting (ZBB) is a budgeting method that allows you to start fresh each fiscal period. It’s different from traditional budgeting because it assumes you’re starting from zero each time you create a new budget, whether that’s monthly, quarterly, or annually.
Companies like Kraft Heinz Co., Unilever PLC, and Walgreens Boots Alliance Inc. rely on zero-based budgeting. When you unpack the details, you can see that it’s a practical method for businesses that want a straightforward yet flexible way to manage income and expenditures.
The ins and outs of a zero-based budget
As the name implies, zero-based budgeting involves developing a new budget from zero dollars every period instead of starting with the previous year’s budget and adjusting as needed. Using the zero-based budget is a great way to ensure that your income is allocated to expenses each fiscal period. This keeps you aware of how much money flows in and out of your business every fiscal period. This can prevent you from spending what you don’t have.
This method is one of the youngest ones: Former Texas Instruments account manager Peter Pyhrr developed the methodology in the 1960s.
One of the main reasons for its popularity is that ZBB allows for a top-down approach to analyzing the performance of a specific project, a specific goal, or a company or department’s overall budget.
It enables accountants and business owners to constantly look at the business with a fresh set of eyes. This makes it quite an innovative approach when compared to the traditional method, which was commonplace long before the birth of zero-based budgeting.
Zero-based budget vs. traditional budget
Zero-based budgeting is the polar opposite of the traditional method of budgeting. Traditional budgeting considers the previous budget’s expenditures and asks for incremental increases over previous budgets.
Zero-based budgeting starts with annual, quarterly, or monthly income, divvies up the money to cover expenses, and ends with zero.
Zero-based budgeting aims to create a clean slate of zero dollars. This gives you a transparent view of your income and expenditures and of what’s financially possible each period. It also forces managers to justify expenses as they must demonstrate a clear need for every business cost in the budget.
Breaking down the zero-based budgeting method
At this point, you know that the zero-based budgeting method is all about starting over every budgeting period—you simply measure your income versus expenditures to determine how to spend your budget for that fiscal period.
You may also use zero-based budgeting alongside other budgeting methods, such as value proposition, which measures the economic value of each department or product.
To use zero-based budgeting, start with this simple formula:
A true-to-form zero-based budgeting example would divide the budget among all business expenses until income minus expenditures equal $0.
For example, a company with a projected income of $1 million should designate every dollar until the entire $1 million is allocated to expenditures, whether they’re fixed, variable, or one-time expenses.
Download our free zero-based budgeting template.
Advantages and drawbacks of zero-based budgeting
As with any business budgeting method, zero-based budgeting has pros and cons. Carefully consider these advantages and drawbacks before deciding whether it’s the proper method for you and your business.
Advantages
- Strategically-focused operations: Managers can better focus on what drives the highest revenue and value in the company.
- Lower costs and budget flexibility: Managers can be flexible when budgeting because they can prioritize expenditures, which, in turn, may lead to lower costs.
- Encourages more communication and teamwork: Determining what business goals you should focus on allows for innovation from all team members. It’s a key aspect to keep your business budgeting intact.
Drawbacks
- Timely and costly: The more often you need to change your budget, the more time it takes—and with zero-based budgeting, you’ll need to reassess how you’re allocating your income regularly.
- May force you to overlook long-term goals: While zero-based budgeting helps managers set and achieve financial goals, this can provide an unwanted blindspot for long-term projects and plans.
Keep in mind that there’s a lot that goes into picking an accurate budgeting process, which is why it’s a good idea to learn more about zero-based budgeting and other budgeting methods.
Manage and lower costs strategically
Zero-based budgeting is a flexible cost management tool because it lets you take your business income minus expenses and then use all the money in the best way possible.
However, although it provides a clear and concise view of your money-spending habits, it can be time-consuming and resource intensive. Also, unlike other methods, this type of budgeting doesn’t account for long-term goals and projects.
Whether you select the zero-based budgeting process as your primary method or decide to opt for a different method to manage your business budget, you also need financial budgeting software that can keep up with your business.
