Zero-based budgeting is a special method of budget planning that is not based on the previous year's budget, but always starts from scratch. In this article we show you why this can be an advantage for companies and how to proceed.
What is zero based budgeting?
In zero-based budgeting, planning is done from scratch each time. This means that you start at 0 and do not use the previous year's values as a basis, as is the case with classical budget planning. This means that the financial resources for the next planning period are always reconsidered.
In zero-based budgeting, it is always necessary to justify why one is using which resources for a particular purpose. The advantage of this is that you can re-evaluate each area of the company during planning and possibly shift priorities - if necessary.
Typically, budget planning is done with zero-based budgeting for a certain period in advance, e.g. for a month or for a quarter. On a rolling basis, the plan can then be adjusted if circ*mstances require.
Zero based budgeting: Why is it important?
Zero-based budgeting enables companies to plan their budgets more flexibly because, unlike the classic method, they are not based on the previous year's figures and do not simply increase them by a certain percentage. This also avoids "fights" over budgets between different departments because everyone receives as much as is justified at the time.
Zero-based budgeting is therefore not only aimed at increasing turnover, but also at optimising costs, because it allows inefficiencies and planning mistakes from previous years to be corrected.
Zero-based budgeting: Process
The process for zero-based budgeting can be divided into several steps:Start at 0: Begin at the beginning of the year with a budget of 0 for each department and division. The previous year's budgets are irrelevant.
- Assessment of the business units: One looks at which activities are planned for the coming year and which activities will not be pursued in the future.
- Justification of budgets: A budget is set for the planned activities. It is questioned whether the budget is justified and whether the activity can be carried out cost-effectively.
This rough planning can be further broken down to individual projects in the departments, for which planning can also be prepared according to the zero-based budgeting method.
Zero-based budgeting: Advantages & disadvantages
Advantages of zero based budgeting
Better cost control
The biggest advantage of zero-based budgeting is that it enables cost control. By not using the previous year's budgets as a baseline, expenditure can be better scrutinised. Those responsible are thus forced to justify their expenditures, which in turn contributes to cost optimisation.
Future-oriented planning
Zero-based budgeting has the further advantage that planning is more flexible. For example, if priorities shift in the company, this can be taken into account more easily because planning always starts at zero anyway. In this way, old things are not unnecessarily held on to. Zero-based budgeting is future-oriented, whereas classical budget planning is past-oriented.
Higher sales increases
The result of the two previous advantages is, at best, a higher increase in turnover. This is achieved on the one hand through more efficient cost control, and on the other hand by questioning past business practices, which can increase process efficiency.
No distribution battles between departments
Since the budget is planned from scratch, the distribution battles that often break out between department heads are eliminated because no one wants to settle for a lower budget than the previous year. Zero-based budgeting avoids this because department heads are required to justify every expenditure. This way, each department gets what it needs to carry out its activities.
Disadvantages of zero based budgeting
Time-consuming planning
The biggest disadvantage of zero-based budgeting is that it is very time-consuming to plan. In traditional planning, the previous year's budgets are simply adjusted slightly and then the planning is done.
This is not possible with zero-based budgeting. Here, department heads have to think more intensively about their expenses and also consult with their staff in order to get a clear estimate for the planned activities.
There can still be disputes
If all department heads sit down together and share their budgets, it can still happen that discussions arise, for example because one division has too low a total budget. Compromises must then be found so that each department is satisfied with its budget.
Summary: Zero-based budgeting's major feature can be a benefit
The fact that zero-based budgeting creates budgets from scratch every year can be a great advantage for companies. If, for example, processes are inefficient or the sales increases of recent years have fallen short of expectations, this method can bring a breath of fresh air into the company.
By questioning the budgets of each department, ideas for innovations have more room. Even if this makes planning more time-consuming, it can provide important insights that can positively influence the company's success.
One can apply zero-based budgeting once and then return to traditional budgeting after redefining the budgets. This process can then be repeated every three to five years. This way, you get the best of both worlds: the efficiency gains from zero-based budgeting and the less time-consuming planning from the traditional method.
