Zero-based budgeting, may be useful for companies looking to align spending with business goals during uncertain times.
Many businesses are shifting into recovery mode after the economic disruption caused by COVID-19. While it’s too soon to divine the lasting implications of this pandemic, most organizational leaders anticipate there will be echoes well into the the forseeable future.
For many businesses, COVID-19 has fundamentally changed expense structures. Travel and entertainment (T&E), for instance, may take a lot longer time to recover to pre-pandemic levels, in part because Fortune 500 companies spend one-third of their T&E on air travel alone. Workforce changes may also impact other workplace-related costs, from rent to heating, cooling, and maintenance.
With these shifts in play, some companies may find that traditional budgeting approaches no longer work as well as they once did. Under normal circumstances, budgeting from a prior period is reasonable. But if this period will barely resemble the last, that may be a less helpful option. The same goes for top-down efforts targeting a specific percentage for reductions. Do across-the-board reductions, with every department cutting 10% or so, even make sense when some expenses have all but disappeared?
This is why some businesses are literally starting from zero. This practice, known as zero-based budgeting, may be useful for companies looking to align spending with business goals. And with the right tools coupled with an agile, active planning model, companies might want to consider this approach to material expense accounts.
What Is Zero-Based Budgeting?
Zero-based budgeting is a method of preparing budgets without carrying over numbers from previous years. Because it requires budget owners to start from scratch, they must review and justify every line item. Zero-based budgeting is not only a cost-reduction strategy, but a shift in mindset, forcing leaders to question entrenched habits and historical assumptions. Questioning old processes may be especially important now as we navigate the many unknowns this global pandemic has introduced.
Introduced in 1970 by Peter Pyhrr, zero-based budgeting remained largely unused and often criticized. But over the last few years, it’s found some fans as finance teams have begun to embrace it. In 2017, Accenture reported a 57% increase in the use of zero-based budgeting annually across the previous five years, based on a survey conducted with 85 companies from the Forbes Global 2000 list. The pandemic has only added to this rise in popularity. According to research from Gartner, 26% of 300 global financial leaders said they planned to implement zero-based budgeting to help manage impacts from COVID-19.
Bottom-Up Budgeting vs. Zero-Based Budgeting
Those new to zero-based budgeting might understandably confuse it with bottom-up budgeting, but they’re not the same.
Bottom-up budgeting, even though it begins at the department level, still uses a traditional approach in that line items are informed by historical spending trends and assumptions. But zero-based budgeting doesn’t rely on a previous year’s actuals, and the new line item could actually exceed the previous year’s if that expense is justified.
The Pros and Cons of Zero-Based Budgeting
Financial leaders historically have had a love-hate relationship with zero-based budgeting, giving rise to a handful of common myths, including that it will lead to cutting expenses “to the bone” or that it doesn’t work for growth-oriented companies.
But there are plenty of pros. For instance, zero-based budgeting allows companies to start fresh by abandoning a reliance on last year’s expenses and instead build the budget from the bottom up. This surgical approach to cutting costs is more strategic, requiring thought and intention around each dollar spent.
Zero-based budgeting also unearths otherwise unquestioned spending. Buried expenses that roll over unquestioned from year to year, yet may no longer serve the company’s best interest, are brought to light and scrutinized. Another benefit is enhanced accountability. Each budget owner must examine and defend his or her future spending, in the process creating a fully invested and informed decision-maker.
Critics of zero-based budgeting claim that it’s too complex and time-consuming to rebuild the budget from the ground up, opting instead for the traditional budgeting approach that relies on historical trends and economic forecasts. Because of its time demands, opponents argue that it lengthens the already too-long annual planning cycle, making it an unreasonable option for many with more traditional planning approaches. Finally, critics claim that zero-based budgeting limits a company’s focus too narrowly on expenses and doesn’t allow it to plan for innovation and growth.
Up until a few years ago, these disadvantages were probably valid. Spreadsheet-based planning was difficult to begin with, and obliterating budgets and plans every year made an already arduous task even harder.
But modern, cloud-based planning solutions have changed the game substantially, and today’s finance teams are using them to work with real-time data, collaborate across departments and business units, and course-correct quickly.
Zero-Based Planning: Best Practices
Organizations looking to explore this rapidly growing approach should take these best practices into consideration:
- Understand that there is no one-size-fits-all. Some finance leaders may feel the need to get granular, diving into detailed line items, while others would do well to roll up expenses into categories.
- Make it company-wide. For the full spectrum of benefits, zero-based budgeting must be integrated into a company-wide planning process. This will help better identify drivers and key correlations, so you can make more strategic and data-driven decisions.
- Be strategic. To avoid a short-sighted focus, stress test your zero-based budget plan by running multiple what-if scenarios to make sure it’s strategic, has longevity, and can meet your long-term goals.
- Use driver-based modeling. Reduce the time required for zero-based budgeting by creating driver-based models that simplify the budgeting process, reduce manual work, and provide consistency across departments.
- Develop a culture of collaboration. Implement the kind of planning culture that encourages managers to partner with finance to discuss or challenge assumptions, model the impact of cost-cutting measures, and explore additional opportunities for operational efficiencies.
- Keep it continuous. Integrate continuous checks into your daily routine to monitor expenses against business goals and changing business environments, and be prepared to make adjustments quickly.
How Companies Use Zero-Based Budgeting
As noted recently in The Wall Street Journal, companies like Guess? Inc., General Motors Co., and Walgreens Boots Alliance began using zero-based budgeting well before the current global pandemic hit.
They’re not alone. Those who adhere to this approach include many Workday Adaptive Planning customers, such as one global food manufacturer that has been using zero-based budgeting to control costs, identify spending areas that create greater value, and improve collaboration. Within the company, more than 1,000 Workday Adaptive Planning users across 20 legal entities apply the zero-based budgeting method. The company divides expenses into subgroups like travel, labor, facilities, and IT, and each area manager is responsible for building his or her own zero-based budget.
For this manufacturer, the benefits have been significant. The approach has given it:
- Increased visibility into the day-to-day expenses, creating stronger and more collaborative teams
- Transparency into where each dollar is going
- Clearly identified opportunities for improvement
Key to this manufacturer’s success is using a modern planning solution with the scalability and resilience needed to meet any demand for budgeting, forecasting, and planning without making compromises for performance. That means modeling without limits, planning continuously and comprehensively to gain a holistic view of the business, and having the ease of use necessary to bring every stakeholder into the planning environment with little to no training.
A solution like Workday Adaptive Planning also streamlines and even automates much of the manual work and data entry that might otherwise make traditional zero-based budgeting a burden. Workday Adaptive Planning enables business-wide planning, from balance sheet and cash flow to zero-based budgeting and expense, personnel, and revenue forecasting.
Establish a Culture of Asking “Why?”
Whether you’re a zero-based planning novice or a full-fledged convert, brush up on these best practices to fully embrace zero-based planning not only as a method to reduce costs but as a strategic mindset for your organization. Establish a culture of questioning the norm and, when it comes to expenses, put in the work to justify the why.
The truth is, it’s all too easy to rely on the way it’s always been done. But in a new and constantly changing world, relying on old habits can have unpleasant consequences.