Perspectives
Zero-based budgeting
Zero or hero?
For many organizations, the thought of rebuilding the company budget from the ground up can be nightmare-inducing. Wiping the financial slate clean and starting from scratch would be a last resort in a worst-case scenario, never an option to be considered under normal circumstances. Yet an increasing number of organizations choose to do exactly that, an extreme method of budgeting known as 'Zero-based Budgeting.'
What is ZBB?
Zero-based budgeting (ZBB) is a budgeting process that allocates funding based on program efficiency and necessity rather than budget history.1 As opposed to traditional budgeting, no item is automatically included in the next budget.2 In ZBB, budgeters review every program and expenditure at the beginning of each budget cycle and must justify each line item in order to receive funding. Budgeters can apply ZBB to any type of cost: capital expenditures; operating expenses; sales, general, and administrative costs; marketing costs; variable distribution; or cost of goods sold.3 When successful, ZBB produces radical savings and liberates organizations from entrenched departments and methodologies.4 When unsuccessful, the costs to an organization can be considerable.
1. Perspective on considering a Zero Based Budgeting (ZBB) planning approach, Deloitte Analysis.
2. Baseline Budgeting vs. Zero Based Budgeting: Americans for Prosperity, 2012. http://americansforprosperityfoundation.com/wp-content/uploads/2014/06/BaselineBudgeting_NtK.pdf
3. Callaghan, Shaun; Hawke, K; Mignerey, C. Five myths (and realities) about Zero-based budgeting, October 2014. http://www.mckinsey.com/insights/corporate_finance/Five_myths_and_realities_about_zero_based_budgeting?cid=other-eml-alt-mip-mck-oth-1410
4. Save to Grow- Deloitte’s Third Biennial Cost Survey: Cost Improvement Practices and Trends in the Fortune 1000. Deloitte POV/Article. March 2013.
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Advantages and disadvantages
Advantages
- Resulting budget is well justified and aligned to strategy
- Catalyzes broader collaboration across the organization
- Supports cost reduction by avoiding automatic budget increases, often resulting in savings
- Improves operational efficiency by rigorous challenging of assumptions
Disadvantages
- Costly, complex, and time consuming as budget is rebuilt from scratch annually, whereas simpler and faster traditional budgeting requires justification only for incremental changes
- May be cost-prohibitive for organizations with limited funding
- Risky when potential savings are uncertain
- Execution challenged by budget cycle timing constraints
- Typically requires specialized training or personnel to accomplish, and requires more resources in general
- May be disruptive to the organization’s operations
- Could harm organizational culture or brand
Download the PDF to explore more of the potential benefits, challenges, and risk associated with ZBB, and whether ZBB components and theory or more practical and less costly budgeting alternatives are suitable for your company.
