Zero-Based Budgeting: A Cost-Savings Deep Clean for Your Business

Spring is here with the end of Q1, and that brings with it the venerable tradition of spring cleaning — an opportunity to scrub away the collected grub and grime of a full year and remove unnecessary clutter from your life. It’s also an opportunity to re-forecast your 2023 budget.

For finance teams, there is a process that’s like a financial version of spring cleaning – though this one admittedly takes place in the fall. It’s Zero-Based Budgeting (ZBB), a process by which the finance team constructs a fresh budget from scratch rather than building off the previous year’s budget.

The normal budgeting process, especially at year end, involves forecasting for the next year, analyzing performance of different budget items, departments, and cost centers, as well as making adjustments to the previous budget according to the forecast.

ZBB takes a very different approach, one that involves communicating with stakeholders across the organization, evaluating what truly needs to be included in the new budget, and starting from zero rather than basing budget items on previous spending.

Why Zero-Based Budgeting?

Why should organizations take on such a challenging task? By essentially starting over from scratch, it allows the business to pare back unnecessary spending. It forces team and department heads to justify expenses by keeping only the most essential budget items.

In short, it’s a powerful cost savings tool that streamlines your company’s budget to its most essential elements. In today’s economic environment, the need for cost savings is clear to all.

Is Your Organization Ready?

While there are incredible potential benefits to this budgeting method, not every organization can implement it right away. First, some kinds of businesses are more suited to it than others. A software company is inherently more nimble and flexible than one that manages physical manufacturing, or that deals with inventory or other logistical challenges.

Beyond that, there is work that should be done up-front to prepare your business for this kind of budgetary overhaul. Specifically, it’s important that you have built a clear model of all your companies financial data. This will allow you to gain a clear picture of where your business stands and take the necessary steps to implement a ZBB approach. I covered data modeling in a recent webinar which you can review to help you prepare.

Steps in the Zero-Based Budgeting Process

Now that you have a better understanding of the concept, let’s take a look at the high-level steps involved in implementing ZBB in your business:

1. Organize all current year expenses

Break down expenses by department and budget owner to provide a clear and easy way to understand current spending. 

2. Extrapolate for the next year

You need to factor in different variables as you look forward. That includes growth of the company including revenue, headcount, or development spending. You might also want to adjust for expected changes to the wider market or what competitors are doing.

3. Review with budget owners

This step is key as you not only need to make sure that your budget is inline with their needs, but also to ensure they buy-in to the process and feel confident they will have the resources they need.

4. Compare budget owner requests to company & management goals

Every budget owner wants to maximize their resources so they can move forward with the projects they want. However, budgeting is a fine balancing act and the needs of each budget owner needs to be weighed against the needs of the wider organization while accounting for its overall financial position.

5. Present the final picture

With management’s green light, you can finalize the new budget and present it to your company’s board for final approval.

What are the Challenges of Zero-Based Budgeting?

One of the potential drawbacks of this approach is that it can scare stakeholders in your company. If they are used to a certain way of operating, or have expectations for a budget based on previous years, it can cause friction for them to have those items challenged.

Additionally, zero-based budgeting will often strip away buffers or other reserved budgets that don’t have an immediate need associated with them. It’s a less flexible approach, especially for other stakeholders in the company. The question is whether the rigidity the process requires is worthwhile in comparison to the potential savings it can provide. What does your business need more of right now? That’s a question only your team can answer.

Tips for Zero-Based Budgeting

Financial Modeling is Key

The starting point for any budgeting process, but especially ZBB, is modeling. If you model your data properly you get visibility to your expenses, and that can help you extrapolate properly for the coming period.

Communicate with Stakeholders

A proper and sensitive conversation between all relevant stakeholders can help prevent friction in the process. The most important thing is to communicate to stakeholders the end goal, as both parties want the same outcome for the company which is better financial performance. 

Allocation of Expenses

Over time, expenses can become independent of any specific manager or executive. Usually, these will include administrative costs (rent and rent related alongside other miscellaneous admin costs). They become entrenched and simply carry over from year to year without anyone directly responsible for them.

So with a ZBB approach, you can make sure that each expense in the company is assigned to a budget owner. In that way you’ll have better control and an easy way to forecast.

Software Budgeting

In these times, as companies are using an increasing number of software providers, one of the most important and necessary controls is tracking all users of those tools and making sure the platforms are being utilized to their full extent. This is a critical component of preventing unused costs.

Final Thoughts

Businesses everywhere are looking to cut costs and extend their runway due to today’s challenging economic situation. ZBB can be an extremely powerful tool in helping businesses achieve that goal. It does require certain compromises from stakeholders, who may need to sacrifice some level of flexibility, but the tradeoff results in far more control for the finance team.

Modeling is a key foundation for ZBB, and Mesh can help play a role in building an accurate model of your company’s expenses through the visibility it provides into spending. To find out more about Mesh and the spend control it can provide, sign up for a demo today.

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