Zero-based budgeting is a way to wipe the slate clean. Frequently used in tandem with a strategic plan, zero budgets help businesses align their goals to their expenses, removing any expenses that don’t fit in their plan.
Learn more about zero-based budgeting, its advantages, and disadvantages, and see if this approach may be right for your business.
Overview: What is zero-based budgeting (ZBB)?
Zero-based budgeting, or ZBB, is budgeting from scratch: looking at each expense or potential expense carefully before deciding to add it to the budget.
Differences between traditional budgeting vs. zero-based budgeting
|Looks at numbers||Looks at goals|
|Requires little analysis||Requires justification of expenses|
|Focuses on cost||Focuses on activity|
|Is simple to prepare||Is a time-consuming process|
|Concentrates on variances||Looks at all expenses equally|
Zero-based budgeting is often used when businesses are looking to cut expenses or reallocate available funds into justifiable expenses.
Preparing a zero-based budget typically takes more time than a results-based budget, as each expense is carefully considered before adding it to the budget. Keep in mind that there are both advantages and disadvantages to zero-based budgeting, which we’ll explain next.
3 advantages of zero-based budgeting
There are a lot of advantages to creating a zero-based budget, especially if your prior year’s budget was wildly inaccurate. Though more time-consuming than creating a standard budget, taking the time to create a zero-based budget can pay off.
When you play a slot machine, many slot players have stated that the money you put into the machine ceases to be money; it’s just a number at the top of the screen.
Budgets are like that. Once a year, we all sit at a table, drinking cold coffee and munching on stale pastries while we determine what should go into a budget. In all actuality, this practice rarely produces any new insights, with most of the budget detail taken from the previous year’s budget, with an increase or decrease factored in.
This process requires little in the way of critical thinking, or thinking at all, instead relying on the amount expended in the prior year.
Zero-based budgeting eliminates prior-year mistakes by the act of justifying any business expense that is included in the budget rather than simply carrying forward the prior year’s mistakes.
Zero-based budgeting addresses both revenue and expense budgeting, with an emphasis on expenses. However, taking a deep dive into your revenue streams is also part of the process.
For example, your travel mugs have always been a hot seller with all of your customers. But the demand for these items has decreased due to more businesses shifting to remote staff. As a result, you’re planning to decrease the number of mugs you purchase for resale in the new year, meaning that revenue totals will need to be adjusted as well as expenses.
That’s what zero-balanced budgeting does. It eliminates past performance, which may or may not be a good fit for your upcoming budget, and forces you to drill down past the numbers to the basis behind those numbers.
3. Better alignment with business goals
Unless you’re creating a budget for the very first time, annual budget creation often involves simply increasing or decreasing prior-year budget totals by a set percentage. This does nothing to address budget shortfalls and inaccuracies, nor does it line up with strategic goals.
Creating a zero-based budget forces you and your employees to carefully examine each revenue source and each expense to determine its place in the budget — and even whether it deserves a place in the budget. Zero-based budgeting helps you consolidate expenses across departments, see exactly where your revenue is coming from, and budget using only that information.
2 limitations of zero-based budgeting budget
The advantages of zero-based budgeting are apparent. But there are some downsides to the zero-based budgeting process.
Even for small business owners, creating a zero-based budget is not a fast process. That’s because each line item in your budget is carefully examined to see if it’s justified. While that sounds simple enough, it can quickly become a tedious, time-consuming process. There’s no doubt that the result can provide a pinpoint accuracy that a standard budget cannot, but it’s up to you to determine whether it’s also time well spent.
2. Employee participation required
If you only have a few employees, this is not an issue. However, for small to midsize businesses with multiple departments, creating a zero-based budget also means that full participation by multiple employees representing multiple departments is required. Without representatives from all departments involved, zero-based budgeting will not be accurate.
How to make a zero-based budget for your business
Creating a zero-based budget is not something that happens quickly. Instead, some basic steps will need to be followed to make the process as efficient as possible. If you have a budgeting tool in your accounting software, you can use that to create your zero-based budget, though there are numerous templates available that can be used as well.
1. Identify goals
Before you start entering budget totals, it’s helpful to have department heads identify their goals. For example, if the sales department’s goals are to increase sales, it’s important to drill down to determine how that will happen. Expenses will follow the same process.
For example, if you plan to increase the size of the sales department, you must also justify that additional expense, with a corresponding increase in sales. If you have consistently paid for an expensive marketing campaign that has brought in zero dollars, now is the time to remove that expense from your budget.
2. Determine how to reach goals
While it’s important to set goals, you must establish a path toward reaching those goals. Will advertising campaigns be used? Will a new product be introduced? Will you try to get your product into more stores? Will you increase your online presence? These are all things that need to be determined before completing your budget.
3. Review all income-producing activities
Zero-based budgeting can help reduce expenses, but it can also help to pinpoint opportunities to increase income. This is particularly important for small businesses with limited income streams. For instance, if you sell only one product, would it be worth the cost to start selling two or even three? Creating a zero-based budget allows you to make these determinations.
4. Consolidate activities and complete budget
Once you consider all income and expenses for your business, you can start to consolidate them and prioritize your spending processes. If you’re currently running two separate marketing campaigns, why not consolidate them into a single campaign and save money? The ultimate goal of a zero-based budget is to use every dollar of income on an expense.
Zero-based budgeting example
If you were going to create a standard budget for the upcoming year, you would use your actual totals from the current year and base your budget on that information.
For example, the budget below displays the actual budget totals for 2020. If you were creating a standard budget for 2021, you’d simply examine each total and perhaps increase the amount by 10-15%.
The zero-based budgeting process is simple, since you’re starting from zero, with each of the line-item expenses closely examined to determine whether the expense should be increased, decreased, or eliminated.
|Office Supplies||$ 1,300|
|Shipping & Delivery||$ 17,500|
|Maintenance & Repairs||$ 11,000|
|Total Operating Expenses||$ 329,300|
You’re now ready to prepare your zero-based budget for 2020. While non-variable expenses such as rent, gas, and electricity can be adjusted upward slightly for the new year when examining expenses, you’ve determined a few things:
• You can save a significant amount of money by switching office supply vendors, resulting in a decrease from $1,300 annually to $900 annually.
• When examining your travel expenses for 2020, you realized that many of the trips your employees made did nothing to increase revenue for your business. You also realized that many of those trips and meetings attended could have been handled remotely, at a fraction of the cost. As a result of these findings, your travel budget drops from $15,500 to $7,500.
• The majority of maintenance and repairs spent involved an old piece of equipment, which has been replaced. As a result, you can drop maintenance and repair costs to $5,000.
• While all your customers previously enjoyed free shipping, shipping costs have continued to rise. As a result, you’ll be charging your customers shipping costs for any orders less than $75. This will allow you to bring the cost of shipping down from $17,500 to $10,000.
• Bundling your internet and phone costs into a single plan will save you more than $1,200 a year, taking the current cost of $3,700 down to $2,500 per year.
• You are also going to get rid of the Other category, figuring that if an expense doesn’t have a category to put it in, it can be eliminated.
|Internet & Phone||$ 2,500|
|Office Supplies||$ 900|
|Shipping & Delivery||$ 10,000|
|Maintenance & Repairs||$ 5,000|
|Total Operating Expenses||$ 304,450|
Using zero-based budgeting, you were able to reduce your expenses by more than 7%.
Is zero-based budgeting right for your business?
Zero-based budgeting is one of the easiest ways to align your expenses with your goals. Different from high-level budgeting or even project budgeting, the point of zero-based budgeting is to have every dollar spent assigned to a particular expense. Using a zero-based budget can also help to pinpoint overspending as well as identify priorities and fund them accordingly.
And even if you don’t use zero-based budgeting every year, creating a zero-based budget every two or three years can help bring your business priorities back into focus.
Original source: The blueprint