For businesses to grow and attain short-term and long-term objectives, entrepreneurs are concerned with every aspect of their business. They strive hard to create and manage a strategic framework (like Zero-based budgeting) for their business, develop a more structured approach to cost management, and find ways to keep the company competitive and profitable.

In addition to this, business owners seek alternative ways to utilize resources and adopt a more resilient approach to control costs in both production and operations.

If you are looking for a tactical budgeting tool that involves budgeting from scratch rather than starting with the previous period’s number, you are referring to Zero-Based Budgeting (ZBB). Before delving into the discussion of its significance, let’s first understand the definition of the ZBB budgeting approach to grasp the concept.

Zero-Based Budgeting

It is a method for developing the budget with zero prior bases. The budget model is built around the upcoming period objectives and carries no balances from the last year’s budget.

How is Zero Based Budgeting is different from Traditional Budgeting?
It includes essential operations and expenses. Activities and needs for budget allocation are evaluated rather than budget history. The strategy requires more maintenance and diligence. You can keep track of everything you spend money on and remove redundant spending.

How To Start Zero-Based Budgeting?

The key steps involved in Zero-based budgeting are:

1. Setting Goals and Objectives

The first step in the budgeting approach involves setting clear, actionable goals. It enables managers to identify and prioritize decision packages parallel to the company’s objectives.

Decision units are the running departments of an organization, and the heads of each unit justify the proposed expenses of their departments while planning. The proposition does not base on the preceding year’s budget but instead on the actual numbers.

2. Evaluation and Justification of Cost Area

Once the objectives and priorities are defined, the analyst will examine the expenses against each activity and evaluate every cost area. It encourages management to relook every item in the cash flow and compute their operation costs. Also, it helps eliminate unnecessary activities and cost reduction to a certain extent.

3. Resource Allocation

Based on the cost-benefit analysis of each unit, available resources are allocated to the departments most economically and efficiently. Optimal resource allocation supports the organization’s strategic goals and ensures that the costing in each decision package is accurate, naturalistic, and free from error.

4. Monitoring and Controlling

It is the last and crucial step on the list helping management track the actual performance of the decision packages with the planned activities. The monitoring gives insights into the decision-making process and aware management of the situation that whether the allocation of resources meets requirements accurately or if any change is required.

Best Practices For Successful Zero-Based Budgeting

For startup founders planning to build a budget based on costs with a justified need, we have compiled a few best practices to help you achieve success.

1. Have Strategic Management of Investments

Zero-based budgeting intends to build long-term resilience; therefore, to avoid a short-sighted focus, CFOs should ensure the drafted strategy has longevity to meet the agreed long-term goals. The cost-cutting methodology gives potential opportunity to the departments to determine the best way to spend company resources and funds on the product lines and activities that drive sales and profits.

For example:
In real estate, a marketing manager can adjust its monthly online marketing budget plan based on the cost-benefit analysis of company marketing resources and the resulting performance.The manager will evaluate the expected lead generation and campaign conversions to allow optimum utilization of company resources.

Based on the revenue generation and profit gain against a specific campaign, the financial expert will plan a strategy for the next round of digital spending. It will give a clear picture to the higher management about the impact of a specific campaign. Hence, its expenditure can be scaled up or down according to your business goals.

2. Workplace Automation

Automation is key to success in corporate organizations. It ensures high-quality results by streamlining inefficient processes and workflows. In a dynamic business environment, businesses should adopt automation to increase work efficiency. It drives down operational costs across departments, reduces manual work, and provides consistency.

This growth-focused budgeting process aligns resources and investments to strategic goals.
Financial analysts seek ways to help improve the business budgeting and planning process. They attempt to harness technology to foster business growth.

Technology aids a company’s operations in the following ways:

• provides detailed insights into what drives expenses and revenues,
• reduces manual work
• saves time
• improves monitoring and reporting system
• advancing business budgeting and forecasting process

Ensure Organization Collaboration

Organizational culture comprises the fabric of the business; therefore, is the key to organizational excellence.
A collaborative environment is considered crucial in implementing a strategic plan. It is effective in empowering employees, attaining strategic objectives, and instilling vital behaviours for organizational success.

To broadly apply this budgeting tool across the business, you will require to put a lot of effort into the alignment of organizational member’s approaches where you need to communicate clearly and created feedback mechanisms for senior leadership.

According to the business professionals, effective collaboration between teams, a commitment to an employee’s action plan, a sense of ownership and open dialogue with senior management led to an environment in which employees at all levels felt that their opinions counted. This eventually led to improved strategy execution, higher performance, adequate resource allocation, and informed funding.

Zero Based Budgeting Example

Here is an example of a simple Zero-based budgeting approach:

One of the departments in an IT-based Company, Paragon, spent $ 20 million the previous year. This year, financial analysts are considering trying some other approach. The members of the higher management decide to increase/decrease the expenses of the department by 10 per cent. Depending on the management’s decision, the respective department will get $ 21 million or $ 19 million.

The company can follow the traditional budgeting model wherein the current year’s budget will be created by considering changes in previous allocations. Then, the company will allocate the same amount as it granted last year without recruiting more employees or increasing production, etc. This way, the department ends up getting $ 20 million.

Another approach is to adopt Zero-Based Budgeting. Here, the managers will not use the base amount from the last year’s budget because the primary objective is to reduce unnecessary costs. Moreover, every dollar will be categorized and justified reflecting the actual requirement of the department and may end up getting $ 30 million or $ 19 million.

Advantages Of Zero-Based Budgeting

Creating an effective budgeting tool to keep your finances on track is key to setting out a successful action plan for your business. But, does ZBB is the best model for you?

Here, we have curated three main advantages for you.

1. Efficient Resource allocation

Cost allocation is a key process in the organization enabling the management to determine the progress of each department whether they are profitable or not. At first, cost objects are identified and a cost pool is created which is then followed by the allocation of resources to the respective business entities.

Here, cost objects refer to a product, a project, or even an entire department that is making profits or losses for the company. It’s an efficient method to calculate direct and indirect expenses incurred and ensure the business’s finances are on right track.

The reports generated by this process are great resources for making a well-informed decision, justifying expenses and thus, pinpointing areas that require raising prices or cutting expenses.

2. Focused Operations

Operating expenses represent indirect costs necessary to keep the business running. However, if the cost of the day-to-day operations exceeds the company’s total revenue, then there will be a negative profit or loss.
Certainly, profits are essential for an organization’s sustainability; therefore, financial analysts attempt to reduce unnecessary expenses by scrutinizing primary cost drivers.

It involves setting benchmarks to:

• assess employee’s performance
• evaluating the department’s performance
• forecasting inflow and outflow of cash
• highlighting profitable areas
• determining loan requirements and,
• calculating manufacturing requirements in conformity to the set goals

An effective financial management tool empowers top management to justify every line item of the cash flow statement by creating a realistic quantitative plan. It will illustrate the actual operations carried out in a company and their alignment with its long-term strategic goals.

3. Effective Departmental Communication

For teams to perform efficiently, effective communication is crucial to carry out between different levels within the organization.

Aligning employees with the strategic goals is key to your business success. This budgetary plan sets a framework for meetings and documentation, fostering a shared vision among employees at every level of the organization. It eventually allows team members to voice their opinions, share their knowledge and participate in the decision-making process.

Final Thoughts:

When selecting a method of producing a budget, consider your needs and goals first.

For instance; what is your sales target? Are you expecting margins to improve? Do you intend to recruit more employees? Will you be making any substantial capital investments soon?

Every entrepreneur should have a clear objective to plan the annual operating budget accordingly. Have you made up your mind on Zero-based budgeting? Are you ready to give it a shot? Great!

The industry experts at Number will help you with strategic and operational planning, create the most efficient budgeting tool and develop a step-by-step plan for moving towards your goal. Schedule a consultation session as per your convenience and availability – and we can talk about the right budget system during the chat.