Two Businessmen Having Discussion In Office

Zero-Based Budgeting: Pros and Cons

Zero-based budgeting (ZBB) is rapidly gaining in popularity, as businesses around the world seek new ways to operate more efficiently, grow their profits, and increase agility. Briefly stated, ZBB dictates that budgets should be assembled from the ground up, with relatively little regard to prior years’ spending patterns. Whereas the traditional budgeting process generally begins with last year’s numbers as a baseline, ZBB starts from zero, as the name suggests.

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Although ZBB represents a significant change in the way finance teams create budgets, it has some distinct benefits, especially for organizations seeking greater agility and cost efficiencies. This article delves into the benefits of ZBB in detail, along with some of the disadvantages of ZBB when compared to a traditional budgeting process.

Zero-based Budgeting Focuses on Needs

For most people, the obvious upside to using zero-based budgeting is that you can eliminate all of an organization’s budgetary “clutter” in one fell swoop. The zero-based approach requires that budget owners justify every expense.

In this respect, ZBB is an excellent means of rooting out the wasteful line items that have accumulated over the years. It helps company leaders to aggressively streamline inflated budgets and to bring costs under control while minimizing any negative impact on operations. In fact, ZBB often results in innovations, helping the company to run more efficiently.

Because ZBB requires managers to scrutinize and evaluate every line in their budget, it results in resource allocation based on current needs, rather than on past trends. In that process, it is very common to discover “legacy” expenses that aren’t necessarily creating a lot of value for the company, but which have persisted in large part simply because of organizational inertia.

ZBB practices would compel a company that routinely pays annual dues subscriptions to a professional association or has an ongoing advertising agreement with a trade publication to examine those expenses and determine how much value they are generating relative to other budget line items. ZBB forces companies to prioritize and take a more intentional approach to costs, focusing on the areas that generate the highest value for the business.

ZBB, therefore, enables companies to cut costs more aggressively because it is a very intentional process. Within the ZBB paradigm, there is no such thing as “across the board” budget cuts.

ZBB Encourages Innovation

Zero-based budgeting also motivates managers to discover new ways to operate more efficiently, to innovate, and to cut costs in ways that don’t adversely affect their departments or lines of business. For example, businesses operating with outdated technology may discover that they can do more with less simply by replacing or upgrading their current systems to more modern alternatives. In the process, they can typically get significant additional value in the form of better, more sophisticated functionality and improved insights that enable better business decisions.

Chart With Increase Value And Decreasing Costs

By the same token, many organizations will, upon implementing ZBB, discover internal functions or business processes that an outside firm could execute more effectively and efficiently. Because ZBB forces companies to examine and justify each expense line in their budgets, it compels managers to look for these kinds of cost efficiencies, and it incentivizes them to do so.

Increased Communication and Collaboration

Zero-based budgeting requires a significant change in the way people think about budgets. In fact, the one major downside is that ZBB can be somewhat labor-intensive, especially the first time a company builds a zero-based budget. That particular cloud has a silver lining: ZBB tends to require increased communication and collaboration among department heads or line-of-business leaders.

Because each line item requires an additional level of scrutiny, and because ZBB tends to push managers toward innovative thinking, the process inevitably leads to broader and deeper conversations throughout the organization. People begin to ask important questions about priorities. ZBB prompts conversations about how the company can do things better, how it can operate more efficiently. Much of the additional “work” required for ZBB is, in fact, critically important communication that has simply never happened before because traditional budgeting processes did not require it.

A Few Disadvantages of Zero-Based Budgeting

So what are the downsides to zero-based budgeting? ZBB can feel like a lot of work, especially when you initially roll it out. That can also be the source of some resistance among stakeholders. After all, discomfort with change is a common phenomenon in most organizations. ZBB requires active buy-in from leaders throughout the company. With the right tools, though, the process can operate very efficiently and will ultimately result in better, leaner budgets.

There are a few other “cons” to ZBB. Some critics say that ZBB can tend to reward short-term thinking by compelling managers to shift their attention (and their budget allocations) to the things that generate immediate revenue, rather than taking the long view.

Another common concern is that ZBB can be problematic for departments in which output is difficult to measure. Public relations, for example, can be a critically important function, and while overall reach and sentiment are easier to measure than they have been in the past, it can still be challenging to put a dollar figure on the value generated by a good PR team.

Finally, some say that ZBB can be easily manipulated by managers who choose to “overpromise and under-deliver.” In other words, they build a budget around promised future benefits, without necessarily delivering on those commitments. The remedy to this problem, of course, is to establish clear accountability, holding people throughout the organization to their commitments by measuring and tracking results against those initial targets.

Making the Process Manageable

Although zero-based budgeting can require more effort than a traditional approach to budgeting, the benefits can certainly outweigh the costs for most companies. To mitigate risks and challenges, many companies choose to take a phased approach to rolling out ZBB, starting with one department or business unit. No matter how you start the process, it’s highly advisable to invest in software that helps managers collaborate around a structured approach and that facilitates broad participation from stakeholders.

With the right tools from insightsoftware, ZBB doesn’t have to mean a lot of work. If you would like to explore the possibility of adopting ZBB in your business, contact us today for a free demo.

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The CFO's Guide to Zero-Based Budgeting

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