Definition
Zero-based budgeting is a budgeting method under which all expenses must be explained starting from zero for a new period against using the previous budget as a base and adjusting it for the new period.Zero-based budgeting (ZBB) helps companies align their expenses with larger strategic goals. This process involves building an annual budget from zero to verify whether each component is cost-effective, useful, and can result in better savings. This tool is commonly used by companies to easily identify and eliminate unwanted expenses, gain better control of spending, and focus on high-profit areas.
Example
A simple zero-based budgeting example would be: Suppose a SaaS company purchased unique technology products from another company for $30,000.It wants to adopt zero-based budgeting for next year. While listing down its expenses, the company realizes that it can make the technology products at a lesser cost than what it paid to the other company. If it builds them internally, it can save $22,000.In its zero-based budget, it will therefore set aside $30,000 – $22,000 = $8,000 as its expense budget for the technology products.
Why it matters
Apart from increased cost savings, ZBB can offer a range of benefits. With ZBB, business margins can be improved through cost savings and aligning expenses with the company’s strategic objectives. It also allows the company to adopt an expense discipline and focus on how each line item can support overall business growth. ZBB allows better alignment of resource planning with projected future growth and improves manager accountability for expenses and imbibing cost awareness. It also allows for impactful engagement of employees in the budgeting exercise.Above all, companies can enhance inter-departmental conversations and build a collaborative culture such that all employees work toward a common goal of limiting expenses to meet larger business goals.