In a world where expenses are constantly increasing, managers and business owners are always looking for new and sustainable ways of reining in costs and better managing expenses.
As per McKinsey & Company, zero-based budgeting (ZBB) is an effective way to free unproductive costs and allow those savings to be taken to the bottom line or redirected to more productive areas of the business that will drive future growth.
What is zero-based budgeting?
Zero-based budgeting, as the name indicates, involves starting with a fresh slate or ‘zero base’ where every function within an organization is analyzed for its need and costs. It is a method of budgeting in which all expenses must be justified for each new period. In this method, there are no balances that are carried forward and no pre-committed expenses that are taken into consideration.
As compared to traditional incremental budgeting, that often blindly allows a nominal increment in the budget for each department (say 10%) with each passing year, ZBB evaluates each area of cost for each department/ function and then passes a fresh budget, which may be either higher or lower than the previous year.
The USP of ZBB is that it forces companies to evaluate options and alternates to make costing more effective and priority based as per current needs and trends.
For example, if a manufacturing company is outsourcing certain parts, ZBB would ask that in the case of the price going up with each passing year, is it better to make those same parts in-house? Would that work in the company’s favor and help save costs? ZBB, thus, helps sustained cost savings in the long run.
Pros and cons of ZBB
- Efficiency in budgeting: ZBB ensures that budgets are made in such a way that there is an efficient and optimum allocation of organizational resources driving growth and productivity.
- High level of employee involvement and motivation: ZBB makes every department and all levels of employees accountable for the expenses they are incurring. It makes them ask vital questions like, ‘Is this necessary? What are the outcomes of this activity? What are the alternate means to achieving it?’
- Reduction in redundant functions: Unproductive activities are done away with and the savings are put either in pushing production or in more customer-facing activities.
- Time consuming: Traditional incremental budgeting is simpler and quicker. ZBB is a time-consuming exercise for a company to do every year for each department.
- Requires manpower and paperwork: Employee involvement for ZBB is very high and there also needs to be a system for accounting and paperwork.
McKinsey feels that the fundamental elements of a ZBB program – governance, accountability, visibility, aligned incentives, and a rigorous process – form a comprehensive cost-management toolkit in the long run. If implemented with thought and senior management lock-in, ZBB can lead to evident benefits for your business.