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Zero Based Budgeting often gets a bad rap.
To some extent, this perception is understandable. Zero Based Budgeting (ZBB) is commonly associated with slash-and-burn cost-cutting by corporate raiders -- the barbarians at the gates who take an axe to budgets – and often jobs -- when restructuring businesses after a hostile takeover.
As such, when talk turns to financial transformation, ZBB often gets left out of the conversation of viable approaches to enhancing and streamlining planning and forecasting.
In my view, that’s a major miss for organizations that are serious about creating significant and sustained transformation. While it’s true that certain elements of ZBB get deployed during major economic or market downturns, that narrow definition significantly shortchanges the real value and vast potential of ZBB.
When I think about this topic, an old familiar saying comes to mind: “Everything new is well forgotten old.” My point: In dismissing ZBB as merely a cumbersome cost-cutting exercise, we lose sight of what it’s really all about – and how it can be a real game changer for finance teams and the companies they serve.
So let’s explore the real—often-overlooked — benefits of ZBB.
The limits of incremental budgeting
Incremental budgeting is probably one of the most common approaches that have usurped ZBB in an attempt to move away from the headaches of having to justify every single expense during the budget process.
No doubt, incremental budgeting is much less time consuming and easier to implement than ZBB – you simply take the last year’s actuals as baseline and add or subtract a percentage based on revenue growth targets or other events. This implies that incremental budgeting does better with established organizations in some kind of “predictable” environment.
Yet taking this easy route rarely delivers the best results. For instance, if a budget manager knows there is potential to increase the budget by 20%, that opportunity is almost always taken without regard for the negative ripple effect it can create. While increasing the budget may be much easier than finding ways to cut costs, doing so likely raises the baseline for the following year and might unnecessarily inflate the budget for the current year as well. Worse yet, this could create a budgetary slack for the company – revenue that could have been deployed for much greater impact in other areas of the business.
The ZBB advantage
Now let’s look at a similar scenario using ZBB -- an approach that encourages collaboration among different business functions to dig deeper into the real cost drivers of the business. ZBB forces you to evaluate each expense, small or large, as a strategic investment into sustainable growth of the company. So instead, of blindly grabbing the 20% budget increase, a manager would be required to justify the move in the context of its impact on a specific department, as well as the company as a whole.
This eliminates assumptions that can be extremely costly. Often, at larger the organization, these assumptions are rooted so deep that managers don’t even know what they are assuming! It’s not uncommon for corporations to pay hundreds of thousands of dollars for services they have not used in years.
ZBB challenges these assumptions and the status quo. It increases accountability by requiring a department head to justify why an expense is necessary. This instills a more strategic cost/benefit mentality that goes a long way toward identifying and eliminating wasted expense, and, instead, deploying dollars in ways that positively impact the bottom line or drive growth.
Quick wins, long-term success
Because ZBB requires shared accountability, it creates the potential for increased meaningful collaboration, and, over time, an improved company culture. Further, the ZBB process leads to people think out of the box to come up with innovative ideas and approaches. The mundane process of incremental budgeting gets replaced by a more dynamic and strategic approach that can lead to true financial transformation.
No doubt, moving to ZBB does take some work. To be done right, it requires buy-in from senior leadership, and commitment from managers throughout the organization. Yet firms that make this commitment to the process often see immediate benefits.
For instance, just the preparation required for ZBB often reveals some “quick wins” in terms of identifying inefficiencies and outdated processes. Over time, those benefits can multiply significantly to create much better cost efficiency and vastly improved planning and forecasting.
Often, it takes two full budget cycles to realize the maximum benefits of ZBB. Yet once it becomes engrained across your organization, the financial, collaborative and cultural benefits can provide a competitive edge that is difficult for competitors to duplicate.
Yes, ZBB may suffer from a reputation problem. But if you have the discipline to look beyond the misconceptions, it can be a secret weapon that takes your company to the next level – and keeps it there.