Know About Zero Based Budgeting and Its Benefits to Your Business

  • September 15, 2021
  • admin

A budget is one of the essential parts of planning a business. Without budgeting, there is no control over the cash flow, and it cannot be known in which direction the business is moving.

A budget will help you project your revenue, determine expenses, and predict your business’s profits. There are multiple different approaches to budgeting, and the method we discuss here is known as “zero-based budgeting.”

Zero Based Budgeting Explained

In zero based budgeting (ZBB), the financial planning of the business is divided into separate periods. In this process, the starting point of a given period is zero funds, so we call it “zero”-based budgeting.

Zero based budgeting means budgeting where each function within the company is analyzed and the required budget justified, with no relation to what budget was allocated previously.

You can get your employees to take part in making a zero based budget. For example, they can provide you with information about the expenses around their allocated area and suggest reducing costs. The expenses that do not benefit a particular function can be done away with.

Here is a ZBB example:

Suppose you run a health spa and charge your customers for various types of massage oil that you use on them. Last year you spent $5000 on herbal oil purchased from an external supplier. You want to use zero-based budgeting this year.

You realize that you can make your in-house herbal oil formulation and save $3000. So, this year, you will pay $3000 less, so if you apply zero-based budgeting, you only need to budget for (5000-3000) = $2000.

The above example covers only one aspect of your business. You can apply ZBB to several other areas of your business.

The result can be a considerable saving in terms of projected expenditures.

Difference Between Traditional Budgeting and Zero Based Budgeting

The cost of goods and services never decreases. Historically, there is always an incremental increase in prices from one year to the next. The traditional budgeting process involves adding a blanket percentage to the budget figures, despite whether each area will cost more or not.

With the zero based budgeting process, each area of the business is considered separately. So, although some business functions may cost more, with a little bit of re-engineering, the cost of running other functions may come down.

So, the primary difference between traditional and zero based budgeting is that there is typically a blanket increase in budget allocation with conventional budgeting. With zero based budgeting, however, there can be a decrease in allocation.

Steps of Zero Based Budgeting

ZBB follows a few specific steps. This form of budgeting looks a bit complicated at the outset. But in reality, these steps are quite simple and follow a structured sequence. The steps of ZBB are as follows:

Identify Business Goals

The ZBB process begins on the assumption that there are no funds available. Next, you will consider the business goals of each function of your business individually.

You need to identify whether the objective is to diversify, increase your customer base, cut costs, increase revenue, etc. These goals should be measurable.

Developing and Analyzing New Means to Achieve Your Business Goals

This stage can be distributed among all the employees of your organization. You need to arrange brainstorming sessions to examine the defined goals and review each one to see the level of efficiency against available resources.

Discover New Ways of Funding

Here, you will look at each expense and examine how it benefits the company toward achieving business goals. In addition, you will find new ways of spending and identify how to cut down on spending for certain functions.

Prioritizing Your Funds

This is the implementation stage wherein you apply funds to the various functions. You can now measure metrics like cash flow, sales figures, and revenue to determine whether the goals have been achieved.

With ZBB, there can be a significant increase or even decrease in budget allocation between different periods. The reason is that no two budgets are linked to each other.

Benefits of Zero Based Budgeting

Here’s how your business can benefit through the ZBB model:

Your First Budget

If you are a start-up, you can benefit the maximum by adopting the ZBB model. You wouldn’t have any previous record to refer to, so you can create the most cost-effective budget solution.

Saves Money

By its very nature, a zero-based budget gives you the breakup and total of how much money you save for a particular year. As a result, your business becomes more cost-effective and thereby more profitable.

Keep a Tab on Your Money

ZBB creates a system of accountability with each function, wherein managers write down how much is required and what it will be used for. This way, you know where the money is going, helping you run your business more effectively.

There are several benefits of zero based budgeting, but there are some downsides to this system as well. Let’s take a look at both sides of the coin:

Advantages of Zero Based Budgeting

  • Cost-effective operations
  • More focus on individual business functions
  • Budget flexibility wherein you can try out new strategies periodically
  • Creates a system of accountability within departments
  • Misallocation of resources is avoided

Disadvantages of Zero Based Budgeting

  • Consumes time and human resources
  • Departments that don’t produce measurable revenue cannot be included
  • The cost of implementing ZBB could outweigh the cost-saving goals

Conclusion

Zero based budgeting is a good way of accounting for every dollar spent on running your business. But it has its downsides, so this model may not be the best solution for all businesses.

However, using ZBB to create your budget plans can be the first step to total control of your business.


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