As the year slowly draws to a close, CFOs also start their annual haggling over costly...
Is Zero-Based Budgeting Still Relevant?
Many large corporations believe zero-based budgeting (ZBB) only applies to small companies that have the time to complete such a granular task. Further, they often don't see the benefit that ZBB can bring to their organizations since those organizations feel a desire to focus more on big-picture planning. This article will emphasize that ZBB is not exclusively for small businesses. It discusses zero-based budgeting as a tool that can be used to improve a company's understanding of is processes, risks, and opportunities and does not need to be applied to every line or department impacted in the budget.
The pressure of globalization and agile decision-making requires companies constantly advance their business models. This may translate into a focus on top-line growth and process improvement. For certain, companies must also have excellent visibility into their costs. A powerful process for identifying cost drivers and ensuring they are managed prudently is through a procedure called zero-based budgeting (“ZBB”).
Zero-based budgeting postulates a budget can be built most effectively from the ground up. Rather than trust last year’s performance as a justified starting point, ZBB involves analyzing cost driver categories, discounting what happened in the past, and approaching the future with a fresh set of eyes. Resource needs are identified almost as if the company is forecasting for the very first time. At its core, ZBB invites cost control since it erases pre-determined assumptions.
At face value, ZBB sounds appealing but the idea frightens many large-company executives since they assume this means discarding the budget and starting over every year. Since many companies already spend a quarter or more on the budgeting process, executives fear zero-based budgeting will take far longer. This is misguided. It’s true that ZBB is a laborious process; however, if done correctly, it’s benefits often far outweigh costs.
The common practice in budgeting is the roll-forward of prior-year results as a baseline for the next year. While there’s nothing wrong with this approach, per se, it doesn’t adequately consider whether last year’s performance was optimized. Just because an organization appeared financially healthy, doesn’t mean it’s established strong cost control. As a consequence of this roll-forward, companies commit planning errors by setting financial targets early in the process and backfilling operating activities to meet those targets. This is backwards, reactive, and doesn’t appropriately address activities necessary to drive the business. Worse yet, it encourages bias and sandbagging to meet arbitrary targets.
Instead, with zero-based budgeting, the company may determine which activities align with strategy and the financial performance that can be expected as a result. This is a very different way of thinking. By holistically focusing on cost-drivers, eliminating unproductive costs, and managing performance throughout the year, companies can realize significant savings in a very short matter of time. ZBB quickly becomes more than a cost-savings exercise; it becomes a process by which a cost-conscious culture is developed and maintained.
From a cultural standpoint, a company needs to ensure the tone is set from the top. Leadership should meet with departmental managers to ensure they understand the importance of ZBB and are fully bought into the process. Leadership should allay staff concerns that the process will be time-consuming, and compensation will be tied strictly to the budget. Instead, staff should understand ZBB means they’ll have greater control in setting their own departmental goals rather than have targets dictated to them from the top. Accountability for adherence to goals should be high.
Companies large and small and across any industries can immensely benefit from zero-based budgeting. The gains come from increased cost visibility, disciplined spending, and strong governance. ZBB is an extremely valuable procedure that reinforces that budgeting should not merely a routine of rolling forward last year’s figures and adjusting them up or down.
The article was first published in Prevero Blog