Volatility in today’s economic landscape means companies are having to embrace cost-conscious policies focused on, above all else, extending runway and driving operational efficiencies.
In fact, business leaders are today focused on coordinating where resources will be spent even before allocating a budget. Companies seem to be afraid of cost management strategies, but this should not be the case – on the contrary, we should embrace budgeting strategies and use them to support the main strategic goals within a business.
I have always envisioned the planning process as an opportunity to effectively scale my business, rather than a hindrance. Accuracy is performance’s greatest ally, and although it might be time-consuming, I opt for a bottom-up methodology suited to best prepare for volatility and uncertainty: zero-based budgeting.
What is zero-based budgeting?
A zero-based budget is a strategic finance approach to corporate budgeting, in which every single resource is thoughtfully distributed to maximize its impact.
In practice, it revolves around starting each budgeting period as a clean slate – i.e., a base of zero – upon which only necessary cost items are added. This gives FP&A teams and budget owners the ability to break free from their status quo, and make conscious decisions about their operating expenses, rather than falling into the old habit of “it was this much last quarter, so it should be similar next quarter”.
Having a culture of cost management is important and I have found zero-based budgeting to help tremendously.
How is zero-based budgeting different from other budgeting methods?
As its name indicates, ZBB provides leaders with a time-agnostic view of their company’s budget, and the different types of costs, irrespective of previous periods. This is a key differentiator between ZBB and other budgeting techniques which enables key decision-makers to focus on looking forwards, rather than backwards. Further, a this process demands exhaustive analysis, evaluation, and cost discipline to determine the need and efficacy of any potential operational expense.
Such thorough cost assessment entails that each expense (e.g. indirect costs, direct costs, administrative costs) is aligned with your governance policies and that it is strictly a necessity in pushing your company forward efficiently (e.g. accomplishing financial goals) – no cost should slip through the cracks unjustified.
Additionally, through the implementation of this methodology, we can encourage healthy strategic discussions around the need for certain costs between various stakeholders, all of which should have a voice in the decision-making process. By facilitating these discussions, we are able to maintain a better handle over how funds get spent – for example:
“Could we live without these specific expenses and instead have that cash available for another investment opportunity?”
What are the advantages and disadvantages of zero-based budgeting?
The question that now remains is: which is the better methodology for financial planning?
Expectedly, there is no easy answer, but there is no denying the value that this framework can potentially bring to companies that are willing to take more active ownership of their expenses and the planning of their annual budgets.
Further, since the success of this budgeting practice hinges on the participation of different budget owners and stakeholders, it implicitly encourages teamwork and communication among individuals within your business in order to think critically, as an organization, about the company’s strategic objectives and the cost structure that supports them.
Finally, ZBB’s time-agnostic approach allows decision makers to eliminate historical bias from their budgeting equation, and focus future planning on the company’s growth requirements, rather than simply taking a historical figure that may be contextually irrelevant and applying a growth rate to it.
That said, these benefits come at a cost that may be too steep for some to pay – specifically in terms of time. A zero based budget can take a long time to execute if not aided by the right tools, and if stakeholders are resistant to change and not fully bought-in to employing new methodologies – the latter of which is a key reason that this budgeting system tends to work best in dynamic, agile environments.
Furthermore, since this budgeting method is primarily focused on the present and short-term future, if not executed carefully it can result in a loss of long-term strategic vision; a potential case of not seeing the forest for the trees.
As such, it’s safe to conclude that ZBB is an undeniably powerful tool in any growing organization – but it must be implemented thoughtfully, and without losing sight of the fact that it should be a tool to help you enable your long-term goals, rather than dictate them.
Why is zero-based budgeting relevant now?
Between inflation and multiple ongoing banking crises affecting companies of all sizes across the globe, we find ourselves once again at a point where investors are less willing to part with their funds, and potential clients are less willing to invest in new products and services.
As a result, the present moment is an ideal time to reevaluate how we think about expenses, and how we can tighten our belts without stifling our business goals – and this is exactly the opportunity that this budgeting practice can provide.
By undergoing the exercise of building our expenses up from 0, we unlock the ability to ensure that each Dollar, Euro, or Pound is put to good use; that nothing is overlooked due to the ease of hitting ctrl+R on your spreadsheet budget.
The ramifications are tremendous: minimizing your unnecessary expenses can mean a longer runway, a new key investment to help generate further ARR, and the ability to catch operational costs before they cause irreparable damage to your finances, or your company.
Best practices for implementing a zero-based budget
Implementing ZBB within your organization is not an exact science – nor should it be. Each company has its own unique situation, and any solution must be adapted specifically for that context. However, I’ve included here some guidelines that can serve as a basis for a strategic approach to employing this at your company.
1. Assign goals and responsibilities
First of all, it is important to agree on which are the pursued objectives when implementing this methodology and how responsibilities and roles will be distributed throughout your team(s) – specifically, who will be the owner of the budgeting exercise, and do they have the resources needed to efficiently and effectively run the project?
2. Determine the granularity level, based on market analysis and internal needs
It is then necessary to discern to what level of detail to break down the data, always based on a previous comparative analysis of the market and taking into account the internal needs of the company. It is useful to answer questions like: does it make most sense to analyze my expenses by department? By country? By business line?
3. Allocate expenses until the total income is matched
Once a specific level of granularity has been agreed upon that provides sufficient value and can be maintained over time, the fun can begin.
In this step, begin the process of listing necessary expenses, starting from – you guessed it – zero. A useful exercise is to do this with the intention of not surpassing your expected monthly income (or remaining as close as possible), as this allows you to focus on maximizing cost-efficiency, and do away with unnecessary expenses or vendor subscriptions that may impact that metric.
4. Analyze results and act
Finally, and most importantly, it is time to put your learnings and takeaway into action. CFOs can empower decision makers to take action towards cutting their unnecessary expenses, benefit from cost savings, and reinvesting their unlocked capital.
This is the most vital piece of the process, and the most difficult to implement due to simple inertia. That said, you as a leader can ensure success by providing your budget owners with support and executive power over their domains. This is where the importance of hands-on culture and dynamic workflows comes into play.
Using an FP&A solution to gain full control over your budgeting process
FP&A software can act as the perfect conduit to allow for a shift to different type of budget processes like the one discussed in this article. Specifically with Abacum, the software does the heavy lifting with regards to consolidating data from various business systems (e.g. ERP, CRM, HRIS), demonstrating quick time-to-value, and acting as a planning tool accessible to the entire organization, not just the FP&A team.
Single source of truth
In terms of centralizing your financial and operational data along with your forward-looking inputs and assumptions, Abacum has no equal. Thanks to its extensive range of accepted integrations, this is a platform on which you can collect a wider range of historical data than anywhere else, all synched directly from their source automatically, making it easier than ever to gather insights and combine them with future assumptions from all of your budget owners within the same platform.
Of course, data remains permission-locked, so you can guarantee that decision makers only see the information they need to plan for the future.
Constructive, not destructive
The market provides a large number of platforms whose learning curve becomes an impossible wall to climb, creating a source of frustration for your team, rather than a value-add. Abacum is intuitive and easy to learn, with an implementation that is guided by our in-house team of FP&A experts who will provide a faster tangible return on investment than any other tool available.
Accessible to all
It is absolutely everyone's job to make the reallocation of resources a success. One of Abacum’s competitive edges is its accessibility, making financial planning a process that the entire organization can participate in – not just the FP&A spreadsheet wizards.
As much as the past serves to better prepare for the future, it is not a guideline for the future. Each context has its reality, and each new budgeting period should be treated as such – a new beginning. Once we adjust our lens to see it as such, we realize the importance of removing historicals from the equation, and making decisions in the present based only on what will be relevant in the future.
As we’ve discussed, taking a more proactive stance on resource allocation and reallocation can yield massive tangible benefits with regards to sustainable ARR expansion, and runway longevity – ZBB specifically has proven successful, when implemented correctly, at accomplishing more effectively than traditional cost-cutting methods due to the emphasis on choosing ‘needs’ over ‘nice-to-haves’.
Additionally, it is a reality that today it is no longer possible to grow at all costs, and taking advantage of the leverage offered by an FP&A tool, rather than financial leverage, is an exceedingly prudent step to take.
The implementation of a cost management policy is indispensable for all businesses that want to stay afloat in our current market reality, maintain competitiveness, regardless of the north star metrics they choose as the measure of their success. The road to profitability has always been a long-distance race in which we must take advantage when the wind is in our favor, and take shelter when it is against us!
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What is the difference between a traditional budgeting process and a zero-based budgeting method?
Zero-based budgeting and traditional budgeting are two different approaches to financial planning and resource allocation. The main difference between the two lies in the starting point and the underlying assumptions used.
Traditional budgeting techniques, also referred to as incremental budgeting, begin with the previous year’s budget as its base. It assumes that current expenditures and operations will continue, and simply adjusts the budget by adding or subtracting incremental amounts for a new budgeting period. This method emphasizes consistency and predictability but may perpetuate inefficiencies or outdated processes.
On the other hand, zero-based budgeting starts from a "zero base" each budget cycle, requiring every expense and line items to be justified anew and a new budget to be created. Departments and projects must demonstrate their value and need for funding, as nothing is automatically carried over from the previous year. It promotes a critical evaluation of cost management and organizational efficiency.
What are the advantages of zero-based budgeting?
- Cost Optimization: It encourages the business to perform a thorough examination of each expense, which can help identify inefficiencies or unproductive costs.
- Resource Allocation: By having to justify every expense, it promotes better resource allocation within a business, as resources are directed towards high ROI initiatives or projects
- Accountability and Transparency: it fosters a culture of accountability between FP&A and budget owners, by requiring departments to justify their budgets rather than allocating without prior challenge.
- Adaptability: Because ZBB does not rely on any historical data, it facilitates a rapid and agile adjustment to changing business conditions or external market dynamics.
- Time-consuming: Zero-sum budgeting can be labor-intensive and time-consuming, as it will require your FP&A team to review and challenge every expense.
- Short-term focus: A zero-based budgeting process emphasis on cost savings can lead to short-term thinking, potentially jeopardizing long-term company goals.
- Implementation challenges: a successful zero-based budgeting process may require significant cultural and process changes, creating a challenge for organizations with deeply ingrained or established traditional budgeting processes.