Dive into the revolutionary world of finance with our latest blog post, where we unravel the power and potential of Zero-Based Budgeting, transforming the way you manage your finances from ground zero.
If done right, zero-based budgeting can translate into cost savings, supporting plans and driving growth. Continue reading to learn how to use zero-based budgeting (ZBB) to improve your personal and business financial health.
Table of contents
- What is zero-based budgeting?
- Zero based vs traditional budget
- Advantages and drawbacks of zero-based budgeting
- Strategies for zero-based budgeting
- Steps for establishing and following a Zero-Based Budget
- Final thoughts
What is zero-based budgeting?
It is a method of budgeting that requires justifying all costs from scratch during the budgeting cycle.
Unlike traditional budgeting techniques that utilize previous budgets as a baseline, ZBB needs an in-depth review of all activities and costs.
Departments must decide on and prioritize their activities, and executives must justify each cost, highlighting the necessity and value it brings to the company.
The budget is then developed upon these justifications, emphasizing essential and cost-effective expenditures aligned with the company’s objectives.
Zero based vs traditional budget
The table below concisely compares traditional and zero-based budgeting, highlighting key differences in philosophy, allocation approach, flexibility, review frequency, cost scrutiny, resource efficiency, decision-making, adaptability, planning challenges, risk management, and departmental involvement.
| Aspect | Traditional Budgeting | Zero-Based Budgeting |
| Philosophy | Incremental adjustments from past budgets | Every budget starts from zero |
| Allocation Approach | Based on historical spending patterns | Allocates funds based on needs |
| Flexibility | Limited flexibility for changing needs | Adapts easily to changing priorities |
| Review Frequency | Yearly or less frequent | Periodic and more frequent reviews |
| Cost Scrutiny | Focuses on overall spending limits | Requires detailed scrutiny of each expense |
| Resource Efficiency | May lead to resource allocation inefficiencies | Promotes optimal resource allocation |
| Decision-making | May perpetuate unnecessary expenses | Encourages strategic decision-making |
| Adaptability | Can be rigid and resistant to change | Embraces changes and adapts swiftly |
| Planning Challenge | Less time-consuming to prepare | Requires meticulous planning and analysis |
| Risk Management | Limited focus on identifying and mitigating risks | Encourages proactive risk management |
| Departmental Involvement | Departments may not have clear understanding of their budget | Departments actively participate in budget creation |
Advantages and drawbacks of zero-based budgeting
The following are the advantages of zero-based budgeting:
- Strategic allocation of resources
Zero-based budgeting fundamentally shifts the process from a routine task to a tactical exercise. Unlike traditional budgeting that depends on historical allocations, zero-based financial planning prompts people to justify every expense from scratch.
This strategic shift guarantees that resources are distributed based on present needs and goals.
By breaking down the financial plan into granular details, individuals can assess the value and need of each expenditure. This scrutiny allows them to wisely distribute resources where they can have the most major effect, encouraging a dynamic and purposeful financial plan.
- Adaptability and flexibility
One of the renowned strengths of zero-based budgeting is its inherent adaptability. Traditional budgets often need help with adapting to shifts in financial circumstances.
In contrast, zero-based budgeting enables effortless adaptation.
When situations change, individuals can quickly reallocate resources when evaluating and distributing funds based on current goals.
This adaptability guarantees the budget remains a living document, able to react to unforeseen costs, income variations, or shifts in financial objectives.
This flexibility contributes to the resiliency of the budget, making it an invaluable instrument in traversing the complexities of developing financial situations.
- Keeps legacy expenses in check
In traditional budgeting, legacy costs may not be considered for years until some economic shock forces the business to take extreme actions. The costs tend to rise over time, with each department protecting its budget from cuts. This method can be narrow, and over time, it may result in significant misallocation of resources.
If done correctly, zero-based budgeting can avoid this from happening.
The following are the drawbacks of zero-based budgeting:
- Planning
Especially when you’re first commencing, zero-based budgeting may involve a lot of legwork. You must determine the % of your income to meet your financial goals and commitments. This can become especially difficult if revenue or expenditures vary substantially from month to month, as you frequently have to make significant changes to your budget.
Even with an ongoing revenue, zero-based budgeting can be demanding. You must ensure that every purchase adheres to the rules you established at the start of the month.
- Resource intensive
Zero-based budgeting is also highly resource-intensive. It takes a lot of effort and time to closely examine and defend every budget element rather than modify a current budget and review only new components.
Strategies for zero-based budgeting
- Select an appropriate planning platform
Modern budgeting and planning software is vital to reap the advantages of zero-based budgeting.
Cloud-based planning solutions utilizing artificial intelligence and machine learning can assist executives in making data-driven decisions to recommend the best path forward.
A budgeting and planning solution should not only be a blank canvas for modelling; it should also contain organizing intelligence and purpose-built abilities for predictive organizing, driver-based budgeting, robust “what-if” scenario modelling, sandboxing, top-down as well as bottom-up budgeting, and authorizations and workflows as best practices that are readily available.
- Determine the quick wins.
Initially, concentrate your ZBB responsibility on the larger and more secure business units having trouble with revenue or selected overhead areas (like general, sales, and administrative expenses) where large hidden expenses are not clearly understood.
Not only will such decisions reinforce the rationale for undertaking ZBB, but they will also result in the greatest cost savings with minimal disruption.
- Adopt a positive approach
ZBB is more than just reducing expenses. It’s essential to freeing the resources and funds required for company renewal and growth initiatives. Working with executives, you can use internal and external benchmarking to demonstrate profitability gaps while clarifying what will happen to the savings.
Steps for establishing and following a Zero-Based Budget
- Step 1. Start with your monthly income
Setting off on a zero-based budget calls for an organized strategy, commencing with your total monthly income assessment. For those on a fixed salary, this involves going through pay stubs or bank deposits to figure out after-tax earnings, encompassing revenue sources. Handling fluctuating incomes requires an in-depth review of the past year, determining low-grossing months as a baseline to prevent overspending.
During months with greater revenue, carefully allocating surplus funds to savings, debt reduction, or discretionary expenses guarantees a balanced financial strategy. This disciplined handle ensures an in-depth comprehension of your financial landscape, enabling careful allocation of resources to vital expenditures, savings, and strategic financial objectives.
- Step 2. List your expected savings and expenditures.
Next, list all the money you’ll spend for the upcoming month. If you aren’t aware of these expenditures, look over your previous months’ credit card and account statements to see where the cash went. You’ll want to note which of these demands are essential- housing, food, health care, and debt repayments—and which are nice-to-haves.
Organizing your needs and wants into categories, such as entertainment, travel, and health care, may be beneficial so you can better track how much you will be spending on what.
Place a target amount you want to spend in every category or subcategory.
Including your monthly savings goals for non-retirement and retirement accounts is also a good idea.
- Step 3. Deduct your expenditures and save the target from the revenue
Finally, deduct your savings and spending targets from your monthly income. You should wind up with precisely zero.
If you come up with a negative number, you’ve decided to allocate more than your means. This is when you will want to review those unnecessary expenses you identified earlier and see what can go. Alternatively, you’ll have to press into your savings—or go into debt—to protect your expenses.
Over the long term, constantly overspending can derail your financial future.
Suppose you conclude with a positive number. Then it’s a good thing! You’ve got additional funds unaccounted for. Check that you’re saving sufficient funds for your emergency fund, retirement, and other short-term financial goals. If that’s the case, you can allocate that cash however you see fit.
- Step 4: Monitor your monthly expenses
Once your monthly tasks are in place, checking once a week ensures you’re still on target to land at zero. A brief review of your online bank and credit card accounts will give you an ongoing reality check.
For instance, if you gave yourself $200 for the month for dining out and already used up $100 in the first week, you must course-correct to not exceed by month end.
Final thoughts
Zero-based budgeting can result in substantial cost reductions and efficiency, but it is much more than simply developing a budget from zero. The main goal of ZBB is to create and promote an accountable and cost-management culture.
With the help of ZBB’s profitability and cost management, narrative reporting, and scenario modelling, your business can think beyond what has been done in the past and prioritize its top operations.
With the cost savings found, executives can then make the necessary modifications to keep up with consumer demands, emerging competitors, and economic trends.
