Zero Base Budgeting (ZBB)
Any action taken by a company stems from a specific process: planning. Planning expressed in terms of investments and financial goals is budgeting. Zero base budgeting is a budgeting method that starts from zero for each budget period. In this approach, all expenses must be justified and no longer just new ones.
Developing a detailed spending plan is the fastest way to reach your financial goals. Generally, a budget helps determine where to spend every penny each month, so you are free to increase it or spend the amounts budgeted.
What is zero-based budgeting?
Zero-Based Budgeting is a unique accounting technique that has specific advantages and disadvantages. Indeed, it forces companies to think about how each of their expenses is managed over a specific budget period. Zero-based budgeting is a budgeting method in which all expenses must be justified in each new period. The process begins with an analysis of the needs of each department of the company and the costs of these needs.
Where does the concept of zero-based budgeting come from?
Zero-based budgeting was first developed in the 1960s by Peter Pyhrr, a controller at Texas Instruments in Dallas, Texas. Around 1970, he published an article in the American journal Harvard Business Review and established himself as an eminent figure in finance.
What makes this method so original? Unlike traditional approaches, all expenses for each new period must be justified and approved. In recent years, this budgeting technique has seen a resurgence in popularity as it has been adopted by a number of Fortune 500 companies as well as private financial firms.
The rise of the zero-based method
In 2018, Accenture Strategy published an extensive study on the so-called “Zero Based Thinking” approach. The results were impressive: Among the 85 largest companies in the world, including Kraft Heinz Co., Unilever PLC and Mondelez International Inc, the zero-based budgeting technique grew exponentially by 57% per year between 2013 and 2017.
What explains the popularity of the zero-based budget? For 96% of companies, this method improves their profitability, while 48% of them said they were influenced by the competition and 40% said that their slow growth caused them to review their budgeting method.
The main characteristics of the Zero base budgeting method
With traditional budgeting approaches, the company starts from the budget of the previous period, which serves as the basis for the next. Therefore,
1. All new budgets increase incrementally from the previous period.
2. Businesses only need to justify the new expenses.
With the zero-based budget method, the budget for each new period is created from scratch, and that is the big difference. All efforts must therefore be justified before being included in the budget, including one-time and recurring expenses.
Planning based on a zero-based budget method starts from scratch, which allows for a more analytical approach.
Typically, each business unit in a company creates its own budget plan based on its needs and presents it to management. In this scheme, no overall budget is drawn up at the outset. Instead, the various budgets are simulated and excess costs are distributed to each new planning period.
Example zero base budgeting template
|Zero Based Budget – Company ABC|
|Summary||Total Projected||Total Actual||Total Variance|
|Total Income during the period||–||–||–|
|Total Expenses during the period||–||–||–|
|Total Balance during the period||–||–||–|
|S.No.||Particulars||Projected (in $)||Actual (in $)||Variance (in $)|
|Income /Funds Received during the period|
|1||Income from Source 1||–||–||–|
|2||Income from Source 2||–||–||–|
|3||Income from Source 3||–||–||–|
|4||Income from Interest||–||–||–|
|5||Income from Dividends||–||–||–|
|6||Income from Pensions||–||–||–|
|Fixed Expenses incurred during the period||–|
|2||Car Insurance Expenses||–||–||–|
|8||Life Insurance premium||–||–||–|
|9||Membership subscription Fees||–||–||–|
|10||Other Fixed Expenses||–||–||–|
|(B)||Total Fixed Expenses||–||–||–|
|Variable Expenses incurred during the period|
|1||Car fuel Expenses||–||–||–|
|2||Car Maintenance Expenses||–||–||–|
|9||Emergency Funds and savings||–||–||–|
|11||Other Variable Expenses||–||–||–|
|( C)||Total Variable Expenses||–||–||–|
|(D)||Total Expenses ( B + C )||–||–||–|
|(E)||Total Balance during the period ( A – D )||–||–||–|
Steps to successful budgeting
The objective of zero-based budgeting is to reduce excess costs by redistributing them according to operational and strategic objectives.
The process is divided into nine steps
- Planning and definition of budgetary objectives and available resources by the management of the company
- Formation of entities that each correspond to certain cost centers; these are typically departments or teams
- Definition of performance levels by entity; it is generally a question of expressing results in terms of quality or quantity
- Formulation of alternatives for each cost center, e.g. to achieve savings
- Selection of the most profitable strategy; that is to say that certain decisions are privileged
- Ranking of alternatives in order of interest, including those that were rejected
- Distribution of available funds
- Validation by the financial department
- Implementation by the finance department of the budgetary measures defined
The advantages of the zero-based budget method
- Resource saving
- Fair distribution of limited resources
- Better flexibility
- Better alignment with business objectives
- A careful examination of overhead
- Improved transparency of the budget process and better understanding of the system
However, it is also an extremely resource-intensive method, which is one of its main drawbacks. In addition, it is more exposed to budgetary manipulation by experienced managers and risks orienting itself towards short-term planning that is too little anticipatory.
It is therefore up to each organization to decide for itself whether the zero-based budget method is suitable for its planning, budgeting and forecasting needs.
Who is zero-based budgeting for?
Zero-based budgeting is often used in very large companies. 25% of these companies would use the BBZ method.
Although it has become a trend, large companies generally use zero based budgeting for part of their activities without radically calling into question their “cash cow” activities.
Sources: PinterPandai, Investopedia, Deloitte, Oracle