Zero-Based Budgeting: The Definitive Guide

Blog
Oct 13, 2022
9 min read
Zero-based budgeting (ZBB) flips traditional budgeting methods upside down, relying less on historical budget allocations and more on priorities of the here and now.

This type of real-time approach has of course become more important than ever in the wake of a pandemic that upended business norms (and the spending priorities that went along with them) and made it imperative for companies to reevaluate their goals, objectives, and spending strategy more often and effectively.

In the sections that follow, we’ll walk through how you can do it. We’ll explore exactly what zero based budgeting means in practice, why it’s growing in popularity right now, business benefits it yields, and best practices for implementation. We’ll also touch on expert coverage of the subject by leading financial expert organizations like the Wall Street Journal and McKinsey.

When you’re done reading, you’ll have all the knowledge you need to move forward with a ZBB strategy for your organization.

Quick Takeaways

  • Zero based budgeting starts every year with a clean slate, requiring all new and past expenses to be justified for the future.
  • ZBB gained momentum during the pandemic as companies needed to totally rethink their spending priorities.
  • Benefits include strategy alignment, visibility, high levels of collaboration, spending accountability, and a culture of responsible cost management.
  • ZBB should be seen not as an aggressive cost-cutting strategy but rather an opportunity for ongoing cost optimization.
  • Best practices include viewing ZBB opportunistically, nailing down your execution process, including stakeholders at every stage, and leveraging technology to enhance your effectiveness.

What is zero based budgeting?

Zero-based budgeting is the practice of starting from budget “ground zero” every year to align spending with current strategic goals and organizational needs. It requires every line item in the budget to be justified for the current period, rather than assumed to be relevant and/or necessary simply because it was so in the past.

Because ZBB starts the budget from scratch each year, it’s a more rigorous process than other budgeting methods, but one that more successfully connects budget and spending practices to higher level strategy. 

The process of zero based budgeting, when implemented successfully, serves as a natural reset button — an opportunity to continually assess how your spending activities should be optimized or adjusted. It aligns strongly with RevOps principles for making revenue growth a strategic priority rather than just a benefit companies hope to achieve.

Zero Based Budgeting vs. Traditional Budgeting

The core difference between zero based budgeting and traditional based budgeting is the stock it puts in past spending practices and priorities. Traditional budgeting typically implements a slight percentage increase across spending categories to account for inflation and rises in wages. Then, it evaluates what should be eliminated, added, or adjusted using the past budget as a template of sorts. While new expenses require strong justification, existing ones are generally added again for the next year in the absence of a glaring reason not to.

Zero based budgeting, on the other hand, starts the budget every year with a clean slate. Rather than using past budgets as a starting point and assuming those line items should be included again, it requires every item to be justified anew. It holds all budget managers and departments accountable for responsible and strategic spending as they operate with the knowledge that their activity will be closely evaluated annually.

Why is zero based budgeting so relevant in 2022?

The pandemic impact

Zero based budgeting was developed by Texas Instruments Inc accounting manager Peter Pyhrr in the 1970s. Over the next five decades, it ebbed and flowed in popularity based on corporate culture trends and the level to which external market factors required deep budget assessment.

The onset of the COVID-19 pandemic in 2020 served as an extreme example of one such market factor. Without notice, companies had to totally upend previous assumptions about spending needs and budget priorities, invest in new technologies just to stay operational, and significantly cut costs as consumer activity was drastically slowed by pandemic conditions.

Zero based budgeting quickly saw a resurgence as companies threw out previous budgets and developed new ones to account for a totally new economic landscape that could not have been anticipated.

“The clean-sheet approach to budgeting has become more popular with finance chiefs during the pandemic because it allows them to cut costs surgically,” said Boston Consulting Group managing director, Luke Pototschnik, in a 2020 Wall Street Journal article. “It also helps chief financial officers budget for longer-term changes in their business . . . The disruptions of [COVID-19] are causing people and companies to fundamentally rethink parts of their budget.”

Looking to the future

As we emerge into a post-pandemic era, the benefits of zero based budgeting have become clearer from a more permanent perspective. Companies now consider financial agility and solid spending governance to be key priorities in navigating fast-changing market conditions.

At the same time, growing adoption of cloud-based platforms to enhance budget tracking and development has made ZBB less tedious, automating much of the process and using AI-powered insights to help business leaders make informed spending decisions.

A follow up article from the Wall Street Journal earlier this year reports on the continued use of zero based budgeting by corporate leaders like General Motors, Hewlett Packard, Hershey, Honeywell International and more. As organizations deal with inflation and prepare for a likely recession, they’re more focused than ever on strategic cost savings and intentional spending.

As Accenture PLC senior managing director, Robert Willems, put it succinctly to the WSJ: “We are seeing a lot of people starting with a clean sheet.”

5 Benefits of Zero Based Budgeting

Budget and strategy alignment

The most notable benefit of zero based budgeting is that it drives true alignment between budget and strategy. Without being tied to historical budget priorities, companies are able to take a strategy-first approach and then build their budget accordingly.

With more intentional and strategically-minded spending practices comes additional benefits like resource optimization and consistent achievement of strategic objectives.

Greater visibility

Zero based budgeting requires a granular approach to budget development. While the process is sometimes seen as tedious, it should also be considered advantageous given the level of visibility it drives across stakeholders. The start-from-scratch approach required for ZBB means that the budget is seen holistically instead of the sum of several siloed parts. As such, every contributor gets to see and understand the budget as a whole (rather than just their individual slice of it).

Higher levels of collaboration

ZBB requires high levels of cooperation, collaboration, and willingness to compromise from business leaders and budget managers across the organization. No line item is a permanent given in a zero based budget, and spending allocation will inevitably shift as internal priorities, external conditions, and other factors evolve. This means stakeholders need to be more flexible in building a budget that most benefits the business as a whole.

It also requires ongoing and frequent communication as the budget is totally reevaluated annually (at least), which drives more organic collaboration as it relates to spending.

Widespread accountability

Knowing that their spending activity will be seen and assessed by a wider audience in their organization naturally encourages budget managers and department heads to act with higher levels of accountability for the effectiveness of their budget strategy.

This means you’ll see less of the budgeting woes often experienced with traditional methods  (think strategic spending priorities that never come to fruition or needless overspending with no worry of repercussions).

Culture of strategic spending

The culmination of the ZBB benefits listed above is a culture of strategic spending that exists across the entire organization.

Rather than being seen as a chore, budgeting and spending can now be viewed as a means for furthering business goals and ultimately delivering better stakeholder experiences (for both employees and customers). Cost management and strategic spending become natural parts of everyday operations rather than an annual (and often unpleasant) undertaking.

Busting Common Myths about Zero Based Budgeting

McKinsey started an important discussion back in 2014 around the true nature of zero based budgeting — in other words, what it actually is vs. the common misconceptions that exist about it. Nearly a decade later, it remains important to recognize and debunk these myths so that organizations don’t unnecessarily shy away from ZBB as part of their strategy.

Let’s walk through each of McKinsey’s five myths:

Myth 1: ZBB simply means building your budget from zero.

Zero based budgeting may mean beginning each year with a clean slate, but it doesn’t mean you have to go back to square one every time.

When implemented successfully, it becomes a repeatable process that you can refine and tailor to your company — for example, by crafting your approach to initial budget evaluation so that it works for your specific teams and stakeholders.

The practice of ZBB eventually also makes cost management a natural part of your employees’ daily considerations as they carry out their responsibilities, meaning they’ll be ready and able to talk about it when the time comes.

Myth 2: Implementing ZBB requires cutting ‘to the bone.’

While companies can experience significant cost savings from zero based budgeting, it’s not the only — or even most important — motivation. Rather, it’s more about connecting spending activities to strategy and business value.

Cost savings as a result of ZBB aren’t a result of just aggressively eliminating spending wherever possible. It happens naturally over time as financial resources are allocated to the right departments and activities, driving higher productivity and revenue growth across the organization.

Myth 3: ZBB will overwhelm your business and prevent it from doing anything else.

To the contrary — zero based budgeting, like any other new method or approach, will take time in the beginning to implement and execute successfully. Once it’s achieved, however, the ROI is long-lasting as a true culture is built around responsible and strategic cost management.

Further, ZBB implementation and ongoing execution is now made easier with the adoption of the right software platform tools to centralize, streamline, and automate your efforts.

Myth 4: ZBB only focuses on SG&A

There is a false understanding of zero based budgeting as a practice focused solely on selling, general, and administrative (SG&A) expenses. While (like any budgeting method) exact details may need to be adjusted across application areas (think line item categories or variability considerations), ZBB can be applied to every kind of cost or area of business.

Myth 5: ZBB is not designed for growth-oriented companies.

Some companies mistakenly view zero based budgeting as a method designed solely for large and established organizations for cutting costs and cleaning up big budgets. But ZBB can (and is) used by high-growth companies of every size to allocate funds to the activities and priorities that most accelerate growth and drive increased revenue.

5 Best Practices for ZBB Implementation

View it opportunistically

Look at zero based budgeting as a way to continually make your organization better. Encourage that perspective from the top-down for a more proactive and enthusiastic approach from every participant.

Include stakeholders at every stage

Incorporating individual budget managers and other stakeholders late in the process goes against the true intention of zero based budgeting. Include them in discussion and planning from the start, considering their feedback throughout.

Nail down your process

To include your entire budget team successfully and make ZBB productive, you need to nail down your process and stick to it (albeit with a level of flexibility). The key is to maintain balance between standardizing for effectiveness while keeping the discourse organic and allowing for situational adjustments to your approach.

Enhance ZBB with technology tools

Take full advantage of the software tools and other technologies available today to make your zero based budgeting strategy efficient, centralized, and highly automated. At Xactly, we recommend a holistic approach, integrating all of your financial processes and strategies into a single platform for data optimization and a single source of truth for your stakeholders.

Celebrate wins

Keep your team motivated by recognizing where you’re succeeding with zero based budgeting and calling out small wins along the way — think successful YOY cost savings, revenue growth, and successful collaboration to execute budget initiatives.

Putting it all together

After decades of existence, zero based budgeting has seen renewed adoption for good reason — it allows companies to connect budget with strategy while aligning spending activity with real-time internal and external demands. It eliminates the harmful “way we’ve always done it” mentality and replaces it with greater levels of accountability from everyone whose decisions impact budget and spending.

Zero based budgeting can be greatly enhanced by the right financial management technology tools. Xactly’s comprehensive Intelligent Revenue Platform (IRP) empowers business leaders to make data-informed decisions around budgets and finances, create predictable forecasts, and drive more resilient and profitable revenue.

Ready to learn how Xactly can benefit your organization? Schedule your demo today!

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